- An operating agreement outlines the relationship between business owners, and articles of incorporation outline a business's relationship with the state.
- All limited liability companies can benefit from having an operating agreement and a certificate of formation.
- All corporations can benefit from having bylaws and articles of incorporation.
- This article is for business owners who want to understand the similarities and differences between operating agreements and articles of incorporation.
An important part of starting a small business is filing all of the proper paperwork. Although setting up the legal structure of your company and filling out forms can seem tedious and daunting, it is often a legally required part of the process. Two documents that many small business owners get confused about are operating agreements and articles of incorporation. There is a good chance that you will need some version of both documents for your business, so it is important to understand the purpose of each one.
What is an operating agreement?
An operating agreement outlines and defines internal operating procedures and relationship agreements between the members (owners) of a limited liability company (LLC). The general goal of an operating agreement is to establish guidelines for how the business owners professionally relate to each other in terms of management and operations. Bylaws are similar to an operating agreement, except they are used in corporations (S corporations and C corporations) instead of LLCs, and they often have statutory requirements for what information they must include.
What should an operating agreement include?
The information you include in your operating agreement or bylaws depends on your specific business and state requirements; however, it generally includes details about ownership, operations, management and financing.
- A description of the business operations
- The separation between the LLC member and the business entity (an outline of how they are separate entities and how they work together)
- The succession plan (how an owner exits and what happens if an unexpected issue with an owner occurs)
- How managers get appointed, and their responsibilities and obligations to the business
- How members/owners get to vote on important issues
- The restrictions of transfer of ownership and how it occurs
- How funds are raised and repaid from the business
- How profits, losses and distributions are to be treated
- How the books and records should be maintained
An operating agreement can also include any other items that you feel are necessary to the operations and protection of rights to the business and its owners.
Does every business need an operating agreement?
Depending on the type of business you have (LLC, S corporation, C corporation) and the state you live in, you may be legally required to file an operating agreement. For example, any LLC conducting business in California, Delaware, Maine, Missouri or New York is required by law to file an LLC operating agreement. Although LLCs in the other 45 states aren't legally required to have an operating agreement, it is highly recommended.
Similarly, corporations (S corps and C corps) are not legally required by any state to have an operating agreement, but experts advise owners of these businesses to create and execute their version of an operating agreement, called bylaws.
"Bylaws establish the rights and duties of the parties involved in the corporation and, if properly followed by the parties, limits the possibility that courts will 'pierce the corporate veil' and hold shareholders personally liable for corporate debts," said Kelly DuFord Williams, founder and managing partner of Slate Law Group. "Additionally, some banks and lenders will ask for corporate bylaws to ensure the legitimacy of the corporation before extending loans or opening accounts."
Key takeaway: An operating agreement (or bylaws for a corporation) is used to establish and outline the relationship agreements between business owners.
What are articles of incorporation?
Articles of incorporation, also known as a certificate of incorporation or corporate charter (certificate of formation for LLCs), is a legal document that formally establishes a corporation in the eyes of the state.
The main benefit of articles of incorporation is the legal protection it provides for your personal assets, since this document separates business assets from business owner assets. Articles of incorporation are often filed with the secretary of state, with a filing fee of roughly $50 to $300.
What should the articles of incorporation include?
The information you include in your articles of incorporation, or certificate of formation, will depend on your specific business and state requirements. However, Gauvreau said each articles-of-incorporation document typically covers the following information:
- The legal name and address of the business
- The purpose of the organization
- How the corporation is required to operate (bylaws)
- The names of the initial directors and incorporators of the entity
- The name and address of the registered agent
- What share ownership is available to be held by investors
- What restrictions are placed on the business activities
- The date it was created
Your articles of incorporation may need additional information depending on the state in which you operate.
Does every business need to have articles of incorporation?
Whether you are legally required to file articles of incorporation will depend on the type of business you own. For example, LLCs aren't legally required to file articles of incorporation, but it is highly recommended for them to have a certificate of formation. On the other hand, every corporation is legally obligated to file articles of incorporation with the state.
"Every corporation must create its articles of incorporation and must file them with the state in which they choose to incorporate," Williams said. "This is the first step in establishing a corporation – the corporation does not exist until the articles are filed."
Key takeaway: Articles of incorporation, or a certificate of formation for LLCs, is a legal document that formally establishes a corporation in the eyes of the state.
Difference between an operating agreement and articles of incorporation
An operating agreement (bylaws) is an internal document that defines how the business owners professionally relate to each other, whereas the articles of incorporation (certificate of formation) is a public document that legally establishes a business as a corporation. Together, these documents help to make up the legal framework of your organization.
Operating agreements and articles of incorporation also differ based on legal structure, obligation, state requirements, tax outcomes, comprehensiveness and rigidity. Operating agreements are often less formal and easier to amend.
"Articles of incorporation are filed as of the date of creation and are often not updated to include shareholder information, profit distribution methods or other ongoing business relations, whereas operating agreements can be more easily adjusted to stay current with the current state of operations," Gauvreau said.
It is also important to understand that, although they serve a similar purpose, operating agreements differ slightly from a company's bylaws. Operating agreements tend to outline items in greater detail than the bylaws of a corporation would.
"In a corporation's situation, it is very common to have additional agreements created, often referred to as a shareholder's agreement, which outlines in greater detail the information that would typically be contained inside an operating agreement," Gauvreau said.
Key takeaway: An operating agreement is an internal document that outlines business owner relationships, and articles of incorporation legally define a business as a corporation with the state.
Similarities between an operating agreement and articles of incorporation
Operating agreements and articles of incorporation work hand in hand to outline your business structure and define how you will legally operate. However, they do have a bit of overlap and share a few similar features. For example, they both include necessary business information and share a similar functionality and outline.
The operating agreement and articles of incorporation "both present information about the business, such as the business name, purpose and how the business will operate," Gauvreau said. "In addition, both documents define the ownership structure and are necessary for understanding the function of the business."
It is wise for every LLC to create a written operating agreement and certificate of formation, and for every corporation to create bylaws and articles of formation. Keep in mind that filing these documents incorrectly can result in delays. To aid in the proper outlining and filing of these governance documents, it is recommended that you seek legal counsel for assistance.
Key takeaway: Operating agreements and articles of incorporation both define business ownership and outline the structure of the business.