Executive Summary
- An operating agreement is a legally binding agreement that establishes the operating and organizational structure of your business.
- An operating agreement is not required by Arizona law, but it is valuable to have for setting expectations and resolving disputes for your LLC, and it is legally binding.
- Important elements of an operating agreement include basic information about the organization, the management structure, decision-making procedures, plans for updating and amending the agreement over time and more.
- When creating your operating agreement, consult a business attorney who can provide support, experience, and advice throughout the process.
Introduction
A limited liability c (LLC) operating agreement outlines the member duties and ownership specifications of your LLC. This agreement gives you a chance to define the working relations and financial concerns among the members (business owners) and between managers and owners.
In Arizona, an operating agreement can include any legally sound provision that relates to the operation of the LLC and involves its employees or members. While Arizona law doesn’t require that you create an operating agreement (unlike some other states) in writing, it’s still important to make one since proving unwritten terms and conditions can be difficult.
It’s important to understand what to include in your agreement so that everyone remains on the same page and you can minimize the risk of future disputes. An attorney can be a valuable resource in the process for ensuring that your agreement is comprehensive and enforceable.
What is an Operating Agreement?
An LLC operating agreement is an internal outline for the general operating rules of your organization, its organizational structure, and how it will be run. This agreement lists all the owners, their contribution amounts, and their percentage of ownership. An agreement also serves the role of establishing the rules for processes, like how decisions are made and how the leadership structure should look.
It’s important to distinguish between an operating agreement and articles of organization. Articles of organization, also known as articles of incorporation, are filed with the Secretary of State to register your company as a legal business entity. Meanwhile, an operating agreement is an internal document that provides direction and clarity around decision-making and processes involved in your LLC.
Legal Requirements for Operating Agreements in Arizona
Before creating an operating agreement in Arizona, there are a few considerations worth making to ensure that it is legally enforceable and covers all the bases.
An operating agreement is not a legal requirement in Arizona—instead, it works as an internal document for guiding decisions and ongoing operations of your organization. As a result, you do not need to file your agreement with the Secretary of State.
You should keep the following in mind:
- Arizona law doesn’t require you to create an operating agreement, but it’s still advisable to make one.
- An operating agreement will lay out what to do in case of future conflict and how to handle important business decisions.
- This document can help prevent conflict between members of the LLC by outlining solutions to potential issues before they arise.
- Working with a lawyer to draft your operating agreement is a good way to ensure that it’s legally sound and fulfills its purpose.
What if I don’t create an operating agreement?
There are no specific legal consequences for not having an operating agreement, but there could be risks to not having one. An operating agreement does lay out important terms and create a roadmap for how your organization should be run, so without one, you could risk actions being taken that are against your interest—this is especially the case if there are multiple members making decisions.
Without an operating agreement, your LLC will be governed by the Arizona Limited Liability Company Act’s laws. These laws cover issues such as members leaving or joining the group and how you should handle profits and losses. The rules outlined in the Arizona Limited Liability Company Act may not perfectly align with your members’ ideals, which is why creating your own operating agreement is the better option.
Not having an agreement could also lead to disputes down the road between members. If your organization featured multiple owners who each provided their own input regarding how the organization would be run, a lack of an agreement could mean that there is no documentation of previously agreed-upon terms or member preferences if an owner decides to make a unilateral decision.
Key Components of an Operating Agreement
Your operating agreement should cover foundational information about the structure of your organization as well as any issues you and the other members wish to address. The following pieces of information are important to include in your agreement.
Basic Information
First and foremost, your operating agreement should include the basic information anyone should know when first discovering your LLC. Relevant information includes the name of your organization and the address of your main operating office, as well as any other locations, if applicable.
You should also address the purpose of your LLC, covering what you hope to accomplish with your services. Helpful information to touch on also includes your mission statement, business goals, and values. If your organization has existed for a few years, you may also consider adding a basic history of your business, how it originated, and what you’ve accomplished so far.
Member Information
An operating agreement should include information about each of the members of the organization. Simply, the agreement should list the names and addresses of all interested members, as well as their role in the business, like if they have a specific title or position in management. You should also include each member’s ownership percentage, if applicable, so that their stake in the business is clear.
Management Structure
An operating agreement should highlight the management structure of your LLC, like whether it will be member-managed or manager-managed. You should answer questions like whether all members have the same management powers or if there will be a central point person for making key management decisions.
The operating agreement should also outline who has important responsibilities or specific roles. For example, the agreement should lay out who will serve as the treasurer and make financial decisions or who will serve as the secretary and document meeting notes.
Distribution of Profits and Losses
You can use the operating agreement to lay out how profits should be split up between group members. This will be helpful for preventing disputes about who should receive what when the business experiences success and who is responsible for filling in the gaps during down periods. For example, if one of your members contributes more financially, you could include in the operating agreement that they receive more of the business profits.
Voting Rights, Procedures, and Rules for Decision-Making
You can also outline rules for how the company will make decisions and use the agreement to restrict members from overruling others to promote their sole interest in the business. Often, voting rights are contingent upon ownership percentage—an owner with a higher stake in the business typically has more decision-making power.
However, you should choose a process that works for you and your members. For example, your team may decide to use a majority voting system, use a two-thirds majority vote, or even require a unanimous decision. You may also have different processes for different types of decisions, such as financial decisions vs. general day-to-day decisions.
Dispute Resolution
As is the nature of any business relationship, disagreements and disputes can occur. An operating agreement can play a helpful role in alleviating disagreements by outlining the process for resolving them. Common ways to resolve disputes include mediation, arbitration, or a general vote. The dispute resolution process will also be resolved by having a strong decision-making structure in place per the operating agreement.
Amendments
Businesses, markets, and personal goals change, so it’s likely that your operating agreement will change at some point in the future as well. Therefore, you should have a process for amending your operating agreement. It will be important to think about how this process would best work for your team in your ideal operating structure.
You may consider some of the following approaches:
- Amendments go to a vote amongst your full team
- A member with managing power oversees amendments
- A designated management team drafts and applies amendments
- Members can make amendments to the agreement under certain criteria
Dissolving the Business
It’s best to include information in your operating agreement about how the company should be dissolved in the event that there are no remaining owners who would like to maintain a stake in the business, and buying out is not sufficient. Some organizations choose a specific date for the business to end, while others leave the date open-ended.
Dissolving an organization includes several steps for appropriately tightening all loose ends and ensuring that there are no outstanding items that could risk personal liability. The agreement can include a voting procedure for handling conflicts such as settling creditor claims, liquidating assets, or asset distribution.
You can also include a procedure for leaving the dissolution of the business according to vote. There may be a chance that some parties may prefer to let others relinquish their role in the organization while buying out the remaining stake and maintaining ownership for themselves.
Planning for State Laws
The operating agreement is also a chance to set up rules for what should happen in specific circumstances that may be altered according to state laws. For example, if one of the members in the group is going through a divorce, the community property laws in Arizona could cause their interest in the company to transfer to their spouse.
Since this might compromise or change the LLC in unwanted ways, you can create a clause in your operating agreement requiring the divorcing member to sell his interest to the rest of the group.
Steps To Creating an Operating Agreement in Arizona
Creating an effective and enforceable operating agreement is relatively simple, but it’s important that you take careful steps to ensure that the agreement reflects your interests and covers all the important bases. Putting detailed thought into the process now minimizes the chances of issues arising in the future.
Take the following steps to create your operating agreement:
- Gather essential information – Gather and outline key information about your business, such as your member information, your organization’s purpose, and the overall structure.
- Consult with your team – Consult your team and discuss what terms you should include in your agreement while ensuring you agree on important operating procedures.
- Draft the operating agreement – Once you have the details clear, you can begin to put all your ideas on paper.
- Review and revise – Review the draft for clarity and completeness, considering whether all potential concerns are covered.
- Finalize and sign – Be sure to finalize the document by having every member sign it.
Once your agreement is fully complete and drafted, it’s also a good idea to maintain a copy of the signed agreement. Everyone having a signed copy on hand ensures that everyone is on the same page and clear on the terms of the document, preventing future disputes later on.
Common Mistakes To Avoid When Creating an Operating Agreement
It’s important that you don’t just craft an agreement to have one but actually take the time and effort to ensure that it covers everything you may need to address. Overlooking important parts of your operating agreement could minimize its effectiveness when you actually need to use it down the road.
The most common mistakes include:
- Failing to include all necessary components of an agreement
- Overlooking the importance of specificity in various roles and responsibilities
- Neglecting to regularly update your agreement as the LLC evolves
- Not consulting legal professionals for advice as necessary
You can draft an agreement on your own, but there is the chance for things to be overlooked because of a lack of experience or simply just a minimal understanding of Arizona laws regarding LLCs. To minimize the risk of any mistakes, you should consult an attorney for support and guidance.
The Importance of Regularly Updating the Agreement
An operating agreement should remain a living and breathing document. Your business can change over time and raise different questions about how to operate it—your agreement should reflect that.
Ownership changes, new business goals, and changes in the market are all reasons to consider adjusting and updating your operating agreement. You should also update your agreement to keep it in line with Arizona laws. A business attorney is a great resource that can help you analyze your agreement to ensure it aligns with local regulations and offer support if any legislation changes occur.
Do I Still Need a Business Plan?
If you create an operating agreement, you should still make a business plan and bylaws. The documents may cover information that overlaps, but they ultimately serve different needs. An operating agreement outlines how your company should be run, while a business plan includes an executive summary of your business purpose, while also communicating financial plans, business strategy, and market research.
How Working With a Business Attorney Can Help
A business attorney can help you ensure that you’ve completed a legally sound operating agreement and that your concerns related to the company are covered. While you may save money initially by choosing not to hire legal assistance, you risk having to pay more later if unforeseen complications arise.
Working with a business attorney offers all the following benefits:
- Legal experience – An attorney will have a deep understanding of Arizona laws and regulations surrounding LLCs, helping you make sure you cover all your bases.
- Custom drafting – An attorney will help you create an agreement that fits the specific needs of your business and each of your members.
- Clarity and precision – An attorney ensures the agreement is clear, precise, and free from ambiguous language, helping you avoid the potential risks of an agreement causing issues in the future.
- Member rights and responsibilities – An attorney will help you clearly define the roles, rights, and responsibilities of each member of your organization.
- Conflict resolution – A business attorney can help mediate potential disputes to manage conflict or avoid it altogether.
- Compliance – Your attorney will ensure the agreement is compliant with state requirements and best practices for LLC operating agreements.
- Review and amendments – Your attorney can also offer ongoing support for reviewing and updating your agreement over time as the business evolves to ensure all contingencies are accounted for as they arise.
Seeking legal counsel is the best way to make sure you fully understand the law and are setting up your LLC management procedures correctly so you don’t have to make corrections later. Contact our business attorneys here at JacksonWhite Law for support in creating and reviewing your operating agreement. Our attorneys will ensure your agreement meets the necessary criteria while helping you draft an
Get Experienced Small Business Representation
You can think of your LLC operating agreement as a prenuptial agreement for the company. It provides members with a thorough framework for how to inform day-to-day operational decisions, handle functional issues related to the business and minimize conflict in the future. As mentioned, you don’t have to get legal assistance to make an operating agreement, but many choose to do so anyway for the added peace of mind.
By working with an experienced small business attorney to create an Arizona LLC operating agreement, you’ll save a lot of extra stress and hassle in the future by protecting your company and the interests of your members. Our team of skilled attorneys at JacksonWhite Law will support you in the process with our decades of experience in business law.
Call JacksonWhite’s Small Business Law Team at (480) 464-1111 to discuss your case today.
Frequently Asked Questions on LLCs
Q: What are the steps for forming an LLC?
To form an LLC, you must choose the state to open it in, then submit Articles of Organization to establish the business as a valid limited liability company. Name the LLC and pick a Registered Agent (also called a Statutory Agent), then file the LLC with the state, create an operating agreement for the business, and get an EIN.
Q: Is a lawyer required to start an LLC in Arizona?
No, you don’t technically need a lawyer to create an LLC in this state. However, if you’re intimidated by the process, need help checking your documents, or have any legal questions, an attorney’s assistance can be an invaluable asset.
Q: How does a partnership differ from an LLC?
While daily business activities are similar for each, partnerships don’t provide liability protection. Partnership owners must personally address business debt and may be affected by their partner’s actions. If you decide to run a business with other members, incorporating and making a formal plan for the company is a good way to protect yourself in the future.
Q: Does an LLC operating agreement have to be notarized?
Arizona law doesn’t require you to have your operating agreement notarized to make it enforceable and valid. However, some people choose to do so anyway for additional evidence to demonstrate all sides’ support of the agreement.
