Operating Agreement Vs Articles of Organization

All future LLC business owners should learn the difference between an operating agreement and articles of organization for 2 crucial reasons.

1. You need one to start your LLC.
2. And the other to avoid internal conflicts and keep your limited liability intact. 

The first is a legal must, the 2nd an optional extra in 45 of the 50 U.S. states.

Now, filing government forms is tedious work, and an optional extra might not sound appealing. But odds are, you’ll need both to grow your business.

To save you time, I’ll tell you the difference between an operating agreement and articles of organization, why both are important for your business and how to file them.

What is an operating agreement?

An operating agreement is the optional extra when forming an LLC. But much like health insurance, you’ll be thankful you have it when needed. 

Operating agreements are internal documents that contain the rules and regulations for an LLC, outlining the ownership structure, management, and operating procedures. It includes details like who owns how much, their rights and responsibilities, how you’ll share profits and losses, and, if the worst happens, how you’ll dissolve your LLC.

The purpose of an operating agreement is to govern your business’ internal operations in a way that suits its members’ specific needs.

Why is an operating agreement critical for an LLC?

An operating agreement is critical when forming an LLC because it explains how you and other members will run the business, removing the possibility of internal disagreements and costly legal battles.

It also protects your LLC liability shield by proving your business is separate from your assets in cases of litigation or debt.

And while you don’t have to create an operating agreement in most states, without one, you might have to comply with your state’s default rules to resolve internal disputes or LLC dissolution, which rarely suits your needs!  

A well-written operating agreement should contain the following information:

• The LLC’s purpose (your industry, what you’ll sell/provide, and how)
• LLC business name and official address
• Member’s names and addresses
• Management structure
• Dispute resolution procedure, like a (Governing law of arbitration agreement)
• Member’s investment contributions
• How you’ll divide profits
• Voting rights
• Whether the LLC is member-managed or manager-managed
• Who the managers are and their duties
• Indemnification agreement, if applicable
• Rules outlining how members can transfer their percentage interest to a third party.
• Conditions for the “right of first refusal” or “right of first offer” on other members’ ownership.

States requiring operating agreements are California, Delaware, Maine, Missouri, and New York. Note that your operating agreement is only enforceable when all LLC members sign it.

Does a single-member LLC need an operating agreement (yes)?

It might sound counterintuitive, but even single-member LLCs need an operating agreement. Not to stop you from arguing with yourself (whatever gets you through the day) but to maintain your limited liability shield of protection.

For example: 

A single-member LLC hair salon owner operating in South Carolina without general liability insurance (link to insurance post when published) or an operating agreement outlining the separation between themselves and the business could be held accountable if a client sues for damages caused by their service.

What are the risks of not having an operating agreement?

The answer depends on your LLC structure, like how many members there are and who owns what percentage. And whether you’re in business with family and friends or purely on a professional level.

Risks can include:

• Disputes among members that cause potential legal battles
• Without an operating agreement, your state’s default rules will govern the LLC’s operations, which can lead to unfavorable outcomes for members, like how you divide profits and losses or make final decisions
• Losing your liability protection and being held accountable for debts or litigation

What are the main benefits of an operating agreement?

Operating agreements exist to protect you and other members from various undesirable situations; the main benefits include:

• Clarity and certainty in the management and operation of your LLC
• Keeping limited liability protection
• Flexibility in the ownership structure and distribution of profits and losses
• Prevention of misunderstandings and disputes among members
• Peace of mind and financial security

Ultimately, an operating agreement can save you time and money by avoiding misunderstanding and resolving conflicts because it helps reduce internal altercations, arguments, debates, and disagreements.

Does an LLC need an operating agreement?

Where to pay your sales and use tax in Texas:

Yes, every LLC should use an operating agreement to prevent misunderstandings and disputes between members and protect the LLC’s liability shield.

What are Articles of Organization?

Articles of organization (also called a certificate of organization or a certificate of formation) are a legal requirement for anyone wishing to form an LLC business entity.

It provides your business location’s Secretary of State with the information they need to form your new business. And to ensure you understand and comply with your state’s laws and regulations.

You file Articles of Organization in the state where you form your LLC. It includes the business names and addresses, the LLC’s purpose, and your registered agent’s contact details.

While state requirements vary, the key steps to file articles of organization are similar throughout the U.S.

Does an LLC need an article of organization?

Yes, every LLC must file articles of organization with the state where they form.

What to include in articles of organization

Similar to filing articles of organization, the information you must include also varies between states; however, most require:

• LLC name
• Purpose/description of your LLC
• LLC’s official business address
• Name and address of your appointed registered (or statutory) agent
• LLC members, managers, and officers’ information
• The date you want to start your LLC

What is the difference between articles of organization and articles of incorporation?

Articles of organization and articles of incorporation are similar, with one key difference:

You file articles of incorporation to form a corporation And articles of organization to form an LLC. ​

What is the difference between an article of organization and an operating agreement?

Articles of organization are an external legal document you file with your state to form an LLC, while your operating agreement is an internal document you create to outline your LLC’s management and operation structure. 

Another way to look at the difference is:

Your operating agreement details the relationship between LLC members, and your articles of incorporation summarize your business’s relationship with your state.

Common mistakes with operating agreements

Common is a little misleading, as each operating agreement is as individual as those who create it and the LLC it serves.

However, there are several mistakes people often make when creating their operating agreements:

Not having an operating agreement

• Only five states in the U.S. require businesses to have operating agreements, so many business owners don’t prioritize creating one.

Failing to customize the document

• Every LLC has unique DNA, and you must customize your operating agreement to fit the needs of your business. Such as including provisions relevant to your LLC to avoid confusion and conflict with other members.

Not including important provisions

• An operating agreement should cover essential provisions like its management structure, members’ voting rights, profit-and-loss distribution, and dispute resolution to ensure everyone remains on favorable terms.

Vague language

• Lawyers and accountants love business jargon, but it has no place in your operating agreement. So, ensure you or they use clear and easy-to-understand language to avoid alternative interpretations.

As Albert Einstein said-“If you can’t explain it simply, you don’t understand it enough!“

Failing to update the document

• You must update your operating agreement to reflect changes in your LLC’s ownership to ensure it remains valid in internal disputes or external litigation.

Not consulting with a lawyer

• An operating agreement is a legal document, so if in doubt, consult with a lawyer or other professional to ensure it’s legally sound and protects your interests.

Not understanding the requirements in your state

• Operating agreements vary by state, so you must understand your state’s requirements and review them on your secretary of state’s website before writing your operating agreement.

Not signing the document

• For your operating agreement to become a legal document you can enforce, all LLC members must agree with the terms and sign it.

Failing to communicate the contents of the document to all members

• All LLC members must understand the operating agreement’s contents before signing to avoid misinterpretation and disagreements.

Common mistakes with articles of organization

Making a mistake on your articles of organization differs from making one on your operating agreement because it’s an official external document that your Secretary of State’s department needs for LLC formation. If you make a mistake, they`ll deny your application. 

To help you avoid that, here are the most common mistakes:

Not researching state requirements

• Each U.S. state has specific requirements for creating and filing articles of organization for an LLC; following them avoids delays or refusal.

Not selecting a unique name

• Your LLC name must be original; this means not already in use by another business entity in your state. You can confirm your name’s availability by doing a name search using your state’s business filing agency’s online entity name check tool.

Not including required information

• Your state can only approve your LLC application when you provide all the relevant information, such as your LLC name, purpose, management structure, and registered agents’ contact details.

Not understanding tax implications

• When you form a legal entity, you must comply with specific state and federal tax requirements. Failing to understand what they are could cost you down the line.

Not seeking legal advice

• Articles of organization are legal documents, so if in doubt, speak with a lawyer to ensure it meets state requirements and protects your business interests.

Not keeping a copy of the document

• When you file your articles of organization, Keep several copies, one for members, another with your registered agent, and one with your accountant/lawyer.

Not updating the document

• Update your articles of organization to reflect changes in your LLC’s ownership or management to ensure your business remains compliant with your state’s rules and regulations. Not doing so could lead to fines or even the closure of your LLC.

Not paying filing fees

• This is a no-brainer; not paying the correct filing fee can cause application rejection.

Tips for getting both right

You have 3 options to create your operating agreement.

1. Single LLC owners could use a template, fill it out, and update it when needed.
2. Multi-member LLC members could work with a local lawyer (they should know your state’s regulations); while it’s more expensive, it can help with partnership complications.
3. Use a business formation service to form and register your LLC, complete all the paperwork, and write your operating agreement. 

The last option is popular with entrepreneurs taking advantage of the low fees and time saving ways to form their businesses. 

Below are 5 steps to creating your operating agreement:

1. Form your LLC

Before you can create your operating agreement, you must form your LLC, as you’ll need to include the details on articles of organization. 

2. Follow your state requirements

Forty-five states don’t require operating agreements, the 5 that do are New York, California, Maine, Delaware, and Missouri. The advantage of living in a state requiring an operating agreement is they provide instructions on completing it. 

3 ways to ensure you’re following your state’s requirements:

• Check your local government website
• Hire a local lawyer
• Use a business formation service

3. Define the provisions

Regardless of which state you do business in, your agreement must provide essential business information. 

Details to include are: 

• LLC business name
• Business address
• Business purpose (what it does)
• Members’ names and addresses
• LLC’s registered agent’s (or statutory) contact details

Multi-member LLCs should schedule members’ meetings to ensure everyone understands and agrees with the operating agreement’s information.

4. Define member guidelines

Multi-member LLCs should define guidelines relative to member ownership, finances, management duties, and payment structure to ensure everything is transparent and all agree. 

Single-member LLCs can add this to their operating agreement if they plan to take on partners or seek investment.

• Contributions: Record all members’ contributions, such as financial, property, transport, equipment, and time.
• Profit distribution: Detail how members will divide business profits. Usually, it’s relative to percentage ownership, but that’s the beauty of an operating agreement as you can divide profits as you want, such as based on working hours, experience, internal roles, etc.
• Percentage ownership: Single LLC owners are the sole owner; however, multi-member LLCs should document all percentage ownership, especially if it determines how you’ll divide profits.
• Management structure: You can run your LLC in 2 ways; as a member-managed or manager-managed LLC, record your decision in your operating agreement and define the manager’s roles, responsibilities, and voting rights.
• Decision making: Remove all doubts on how your LLC will run by recording how voting works, such as percentage ownership, majority or unanimous decisions, and who, if anyone, has the final say.
• Member withdrawal: Confirm what will happen to a member’s shares should one leave or die.

For example, if a member leaves, will the remaining members get first refusal to buy the shares? Or how will the LLC pay shares to their next of kin if one dies?

Important Note:

Multi-member LLCs with 2 owners can give 2 shares to someone they trust (like an accountant or business confidant) who, in a stalemate between partners, can vote to choose the best course of action for the LLC. 

5. Finalize the Operating Agreement

Once all members agree on the operating agreement, you can complete it. 

Here’s how you make your operating agreement official:

• Sign it: All members must sign the agreement for it to become official and enforceable.
• File it with your state: For LLCs in one of the 5 states that need operating agreements, you must file it with the appropriate government department. Contact your local county clerk’s office to find out where.
• File it internally: Make several digital and paper copies to ensure they’re available if needed, and give one of each to your attorney, accountant, and registered agent. And for multi-member LLCs, ensure each partner has their copy.

Tips for filing Articles of Organization

Articles of organization requirements vary by state, so take these 3 steps before completing your state’s application form:

• Research your state requirements and ensure you meet them when drafting your document.
• Check with your state’s business registration office to ensure your chosen business name is available before you file your articles of organization.
• Ensure you provide complete, accurate information; otherwise, your state might reflect your application.

Next, follow these tips to file your articles of organization correctly: 

1. Choose an available name for your business
2. Download the articles of organization form from your Secretary of State’s website
3. Select your registered agent
4. Complete, sign, and include your LLC operating agreement
5. Confirm how you’ll run your LLC, member-managed or manager-managed
6. Sign your articles of organization
7. Send to your Secretary of State’s Office
8. Make sure you pay the filing fee (usually digital, but some states require a cashier’s check)

Conclusion

When you start your business, completing government forms and other legal documents is part of the process. 

Some are obligatory, others optional, like commercial auto insurance. But you wouldn’t drive without it, would you? 

Consider an operating agreement as your LLC`s internal insurance policy that secures your assets and partner relationships.

The only difference is that an operating agreement is free, and you get to create the terms!

So, why take the risk and run your business without one? 

FAQ