- 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 (LLCs) 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.
Filing the proper paperwork is an essential element of starting a business. Although choosing the best legal structure for your business and filling out forms can seem tedious and daunting, these steps are often legally required parts of the process.
Many small business owners get confused about operating agreements and articles of incorporation. There’s a good chance you’ll need some version of both for your business, so it’s important to understand each document’s purpose.
What is an operating agreement?
An operating agreement outlines and defines internal operating procedures and relationship agreements among the members (owners) of a limited liability company (LLC). An operating agreement’s general goal is to establish guidelines for how the business owners professionally relate to one another in terms of management and operations.
Bylaws are similar to operating agreements, except they’re used in corporations (S corporations and C corporations) instead of LLCs, and they often have statutory requirements for the information they include.
An LLC is a business structure that protects a business owner’s personal assets from business debts or if the business faces a lawsuit or files for bankruptcy.
What should an operating agreement include?
The information you include in your operating agreement or bylaws depends on your business’s and state’s specific requirements. However, an operating agreement generally includes ownership, operations, management and financing details.
Robert Gauvreau, CEO of accounting tax law advisory firm Gauvreau, created an outline for the information an operating agreement should cover, including the following elements:
- 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 other items you feel are necessary to business operations and the protection of the business’s and owners’ rights.
Does every business need an operating agreement?
Depending on your business type (LLC, S corporation, C corporation) and state, you may be legally required to file an operating agreement. For example, any LLC conducting business in California, Delaware, Maine, Missouri or New York must 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. Still, 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, limit 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.”
Bylaws often include succession-planning agreements and decisions. This prevents business closure when a founder dies or an owner exits the company.
What are some common mistakes with operating agreements?
Experts say business owners sometimes make the following mistakes when creating operating agreements:
- Excluding important information. When rushing to put your business’s operating structure in place, it’s tempting to cut corners and skip seemingly unimportant sections of Gauvreau’s outline. However, all the items in that outline are included for a reason. It’s essential to include every part of the outline.
- Including too much information. On the other end of the spectrum is including too much information in your operating agreement. A lawyer specializing in LLC affairs can identify sections that could cause more problems than they solve.
- Using vague language. An operating agreement should be clear and precise. Working with an expert on operating agreements can help you leave no room for confusion or misinterpretation in your agreement’s language.
- Keeping it the same forever. Periodically checking your operating agreement to ensure it remains valid and relevant is key to a solid agreement. Experts suggest reviewing your agreement with a lawyer once a year to identify potential areas for change.
Can you change your operating agreement in the future?
Yes, you can change your operating agreement. Doing so is typically easy. You won’t have to file revisions with any government or regulatory bodies. You’ll need to gather your LLC members to approve changes via written amendments. You’ll then store this file alongside your original operating agreement for documentation purposes.
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, because this document separates the business’s assets from the business owner’s assets. Articles of incorporation are often filed with the secretary of state, with a filing fee of roughly $50 to $300.
What should articles of incorporation include?
The information you include in your articles of incorporation or certificate of formation will depend on your business’s and state’s specific requirements. However, Gauvreau said each document typically covers the following information:
- The legal business 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 the business was created.
Your articles of incorporation may need additional information depending on the state where 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 LLCs 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,” DuFord Williams said. “This is the first step in establishing a corporation – the corporation does not exist until the articles are filed.”
What are some common mistakes with articles of incorporation?
Business owners sometimes make mistakes when creating and filing articles of incorporation, including the following:
- Not reviewing and adhering to state guidelines. You should double-check that any guides you’re following about how to file articles of incorporation pertain to your state. Rules for filing can differ substantially by state. You should also confirm that any attorneys you work with are well versed in your state’s guidelines.
- Choosing an invalid registered agent. Not just any person or company can be the registered agent for your articles of incorporation. This person or company must live in the state where you file your articles. They also must be easily reachable, so choose a registered agent who works regular business hours within your state.
- Confusing them with articles of organization. A corporation must file articles of incorporation, whereas an LLC must file articles of organization. Check your filing body’s website for the proper forms, and ensure you’re actually filing the forms that are relevant to your business type.
- Filing with the wrong government body. Some states require that you file articles of incorporation with the secretary of state’s office. Others require you to file with the state commerce department or another government body. Double-check that you’re filing with the correct office to avoid any problems or delays.
To open a business bank account, you’ll need your articles of incorporation along with an employer identification number and personal identification documents.
Can you change your articles of incorporation in the future?
Yes, you can change your articles of incorporation. Although the process may vary by state, it typically starts with filing a document called a certificate of amendment and paying a fee. What this document should detail also may vary by state, but you can start by including the following information:
- The names and titles of the people at your corporation who are certifying the changes (typically your board’s president and secretary).
- The article of incorporation you’re amending.
- Confirmation that your board has approved the amendment via a corporate resolution.
- Confirmation that the number of shareholders required in your articles of incorporation and/or operating agreement has approved the amendment upon a vote.
What’s the 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 one another. The articles of incorporation (certificate of formation) is a public document that legally establishes a business as a corporation. Together, these documents help make up your organization’s legal framework.
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 crucial 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.
“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.
What are the 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 your company will legally operate. However, they do overlap a bit and have a few similar features. For example, both documents include necessary business information and have similar functionality and outlines.
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.
Both operating agreements and articles of incorporation should include the business’s legal name and any DBA (doing business as) name.
Starting your business the right way
Launching a business involves more than opening your doors to potential clients or customers. It also means setting up formal internal protocols and registering with the government. These parts of forming a business can be tedious, but if you get them right the first time, you’re off to a great start.
Max Freedman contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.