An important part of launching a company is submitting the required documentation. Forms and selecting the right legal structure for your company might seem dull and difficult, but they are often necessary stages in the process.
Operating agreements and articles of incorporation are two topics that many small company owners find confusing. It’s crucial to comprehend the function of each document since there’s a strong probability that your company may want some variation of both.
Also Read: Self-Employed? Everything You Need to Know About Taxes
What is an operating agreement?
An operational agreement explains and specifies internal operating processes and contractual arrangements among a limited liability company’s members (owners) (LLC). Establishing standards for how the company owners should interact professionally in terms of management and operations is the main objective of an operating agreement.
Operating agreements and bylaws are similar, except bylaws are used in companies (S corporations and C corporations) rather than LLCs, and bylaws sometimes include legislative requirements for the material they contain.
What should an operating agreement include?
The exact needs of your company and state will determine what information you should include in your operating agreement or bylaws. An operational agreement, however, often contains information about ownership, operations, management, and funding.
According to Robert Gauvreau, CEO of the accounting, tax, and legal consultancy business Gauvreau, the following topics should be included in an operating agreement:
- A breakdown of how the firm is run.
- The division of the corporate entity and the LLC member (an outline of how they are separate entities and how they work together).
- The transition strategy (how an owner exits and what happens if an unexpected issue with an owner occurs).
- How managers are chosen, as well as what duties and commitments they have to the company.
- How owners and members cast votes on crucial topics.
- The limitations on and mechanisms for ownership transfer.
- How the firm raises money and returns it.
- How to handle payouts, earnings, and losses.
- How to preserve the books and records.
Other provisions that you deem important for business operations and the defence of the company’s and owners’ rights may also be included in an operating agreement.
Does every business need an operating agreement?
You could be required by law to register an operating agreement, depending on your business’s legal structure (LLC, S company, or C Corporation) and state. For instance, an LLC operating agreement must be filed if the LLC does business in California, Delaware, Maine, Missouri, or New York. Although operating agreements are not legally necessary for LLCs in the remaining 45 states, they are strongly advised.
The existence of an operational agreement is also not mandated by any state’s laws for companies (S corps and C corps). However, experts encourage the owners of these companies to draught and adopt their own bylaws, which are a kind of operating agreement.
According to Kelly DuFord Williams, founder and managing partner of Slate Law Group, “Bylaws establish the rights and obligations of the parties involved in the corporation and, if properly followed by the parties, limit the possibility that courts will ‘pierce the corporate veil’ and hold shareholders personally liable for corporate debts.” Before making loans or establishing accounts, certain banks and lenders may also request copies of the corporation’s bylaws to verify the authenticity of the entity.
What are some common mistakes with operating agreements?
According to experts, company owners sometimes commit the following errors while drafting operating agreements:
Excluding important information.
It might be tempting to scrimp and pass over parts of Gauvreau’s framework while hurrying to set up your company’s operational structure. But each component of that plan is there for a purpose. Each section of the outline must be included.
Including too much information.
The opposite of this is true if your operating agreement has too much detail. A lawyer with experience in LLC matters may see clauses that can create more issues than they resolve.
Using vague language.
An operational agreement has to be explicit and unambiguous. You may avoid any ambiguity or misunderstanding in your agreement’s terminology by working with a specialist in operating agreements.
Keeping it the same forever.
A strong operating agreement depends on routinely reviewing it to make sure it is still applicable and effective. A lawyer should examine your agreement once a year to look for possible areas for adjustment, according to experts.
Can you change your operating agreement in the future?
You may alter your operating agreement, of course. Usually, doing so is simple. You won’t need to submit modifications to any administrative or governmental agencies. You’ll need to assemble the members of your LLC to approve adjustments in writing. Then, for record-keeping reasons, you’ll keep this file with your original operating agreement.
What are articles of incorporation?
A corporation is legally established in the eyes of the state by the filing of articles of incorporation, sometimes referred to as a certificate of incorporation, corporate charter, or certificate of formation for LLCs.
The primary advantage of articles of incorporation is the legal security it offers for your personal assets since it distinguishes between the assets of the company and those of the business owner. A filing fee of between $50 and $300 must be paid to the secretary of state when submitting articles of incorporation.
What should articles of incorporation include?
The unique requirements of your company and state will determine what information you must include in your articles of incorporation or certificate of formation. Gauvreau noted that each paper normally includes the following details:
- The company’s address and formal business name.
- The organization’s mission.
- How the company must conduct its business (bylaws).
- The names of the organization’s first directors and incorporators.
- The registered agent’s name and address.
- What types of ownership are accessible to investors?
- What limitations are imposed on corporate operations?
- The day the company was founded.
- Depending on the state in which you do business, your articles of incorporation can need extra information.
Does every business need to have articles of incorporation?
The sort of company you own will determine whether or not you are obliged by law to submit articles of incorporation. For instance, while filing articles of incorporation is not legally needed for LLCs, having a certificate of formation is strongly advised. On the other side, it is required by law for every company to submit its articles of incorporation to the state.
According to DuFord Williams, “any corporation must draught its articles of incorporation and submit them with the state in which they want to incorporate.” “This is the initial stage in forming a company; until the articles are submitted, the corporation does not exist.”
What are some common mistakes with articles of incorporation?
When drafting and submitting articles of incorporation, business owners might commit a variety of errors, such as the following:
Not reviewing and adhering to state guidelines.
You should make sure that any instructions you follow for submitting articles of incorporation are appropriate for your state before proceeding. State-by-state filing regulations might vary greatly. Additionally, you should make sure that any lawyers you choose are knowledgeable with the laws in your state.
Choosing an invalid registered agent.
The registered agent for your articles of incorporation cannot be simply anybody or any organisation. This individual or business must be a resident of the state in which your articles are filed. They must also be simple to contact, so choose a registered agent that operates throughout normal business hours in your state.
Confusing them with articles of organization.
While an LLC must file articles of organization, a corporation must file articles of incorporation. To be sure you’re truly submitting the forms that are pertinent to your company kind, check the website of your filing body for the correct paperwork.
Filing with the wrong government body.
You must submit articles of incorporation with the secretary of state’s office in several states. Others demand that you submit paperwork to the state commerce department or another bureau of government. To prevent issues or delays, double ensure that you are filing with the right office.
Can you change your articles of incorporation in the future?
You may alter your articles of incorporation, of course. Although it may differ from state to state, the procedure usually begins with the submission and payment of a certificate of modification. State-specific requirements may also affect what this paper should include, however you may start by incorporating the following details:
- The names and positions of the employees at your company (usually the president and secretary of your board) who are confirming the modifications.
- The amendment to the articles of incorporation.
- A corporate resolution attesting to your board’s approval of the modification.
- Confirmation that the adjustment was authorized by a majority of the shareholders specified in your operating agreement or company’s articles of formation.
What’s the difference between an operating agreement and articles of incorporation?
An internal document known as an operational agreement (bylaws) outlines the firm owners’ professional relationships with one another. A public document known as the articles of incorporation (certificate of creation) formally establishes a company as a corporation. These papers work together to provide the legal foundation of your company.
Operating agreements and articles of incorporation vary from one another in terms of their rigour, thoroughness, comprehensiveness, obligation, state requirements, and legal structure. Operating agreements are often more flexible and less formal.
Operating agreements can be more easily updated to reflect the current state of operations than articles of incorporation, according to Gauvreau. “Articles of incorporation are filed as of the date of creation and are frequently not updated to include shareholder information, profit distribution methods, or other ongoing business relations,” he said.
It is also important to realize that operational agreements and a company’s bylaws are somewhat different documents, even if they have identical purposes. Operating agreements often include more specific details than a corporation’s bylaws.
According to Gauvreau, “In the case of a company, it is extremely normal to have extra agreements made, sometimes referred to as a shareholder’s agreement, which specifies in more depth the information that would ordinarily be provided within an operational agreement.”
What are the similarities between an operating agreement and articles of incorporation?
Your business structure and the legal operations of your firm are outlined in your operating agreements and articles of incorporation, respectively. They do, however, have certain similarities and some areas where they overlap. For instance, both papers have identical functionality and outlines and both include important business information.
According to Gauvreau, the articles of incorporation and operating agreement “both offer information about the company, such as the business name, purpose, and how the firm would run.” Both contracts also specify the ownership structure and are essential to comprehending how the organisation operates.
Every LLC should draught an operating agreement and certificate of creation, and every corporation should do the same with bylaws and articles of incorporation. Remember that delays may occur if these papers are filed improperly. We advise you to consult legal advice for help in the correct drafting and submission of these governance papers.
Starting your business the right way
Opening your doors to prospective clients or consumers is only one aspect of starting a company. Additionally, it entails registering with the government and establishing official internal processes. Although these steps in the company formation process might be laborious, if you do them right the first time, you’re off to a wonderful start.