Operating Agreements and Bylaws: What’s the Difference?
Understanding the differences between operating agreements and bylaws is essential for establishing a solid foundation when forming a business. Both are essential to the business structure but serve different purposes depending on the entity being created.
Let’s explore the primary variables, discuss the purpose of each document, and explain why having these agreements in place is vital for your business’s longevity and success.
Business Structure Agreements: An Introduction
Starting a business requires more than having a sellable idea and filling out paperwork. Business owners must carefully plan and establish clear guidelines for operating the company. These operating agreements are different than the bylaws required for other, more nuanced purposes.
Operating Agreements vs. Bylaws
How your business is organized from a legal and operational standpoint affects its routine functions and long-term viability. For example, corporations generally use bylaws to govern their internal operations, while LLCs use operating agreements to define the responsibilities of shareholders or members. Both documents address how profits and losses should be managed.
What Is an Operating Agreement?
An operating agreement is a legal document used by LLCs to outline the company’s internal management. While it’s not required in every state, operating agreements are highly recommended to avoid default state rules that might not align with your vision for the business.
Key elements typically include:
- The ownership structure and member interests
- Voting rights and procedures
- Profit and loss distribution
- Management roles (member-managed/manager-managed)
- Add/remove member procedures
- Company dissolution plan
Operating agreements are customizable with skilled legal counsel, but an OA should act as a contract between the LLC’s members. The point is to set rules and expectations for how the business will be run. However, it also allows for some flexibility in structuring the company’s finances and management according to evolving member preferences.
What Are Bylaws?
Bylaws are business structure agreements that govern corporate operations. Once the corporation is legally established by filing articles of incorporation, the next step is drafting these bylaws. The documents will detail how the corporation will be governed and operated based on shifting circumstances.
Corporate bylaws typically include:
- Voting rights of shareholders and directors
- Officer roles and responsibilities
- Guidelines for issuing stock
- Procedures for holding meetings with board members and shareholders
- Board of Directors roles and responsibilities
- Procedures for amending the bylaws
Unlike operating agreements, bylaws are usually required by law in most states for corporations. They are crucial for setting up formal governance processes and ensuring all directors, officers, and shareholders understand their rights and responsibilities. Bylaws also guarantee a corporation operates in a structured way that follows regulatory compliance.
Operating Agreements and Bylaws: Key Differences
The most significant difference between operating agreements and bylaws is the type of business entity they govern. For instance, an OA is specific to LLCs, but bylaws are specific to corporations. However, the differences don’t end there.
Other notable variations include their scope, legal requirements, and flexibility. Operating agreements are not necessary in every state, but bylaws usually are. Moreover, OAs offer far more fluidity in terms of structure, with LLC members able to define their own rules and procedures. Bylaws, on the other hand, are more rigid and formal.
Operating agreements vs bylaws: it’s all about the content focus. OAs center on internal workings, including internal interests and profit sharing. Conversely, bylaws outline how decisions are made and how officers are appointed.
Why Are Business Structure Agreements Important?
A formal business structure agreement is critical because these documents are the backbone of businesses. They help provide the clarity required to prevent disputes and misunderstandings, but they also protect the business’s legal status. Moreover, investors, banks, and other financial institutions will often want to see operating agreements and bylaws before providing financing.
Get Help with Operating Agreements and Bylaws
Well-drafted business structure agreements are essential to ensure smooth operations, clear communication, and long-term success. While understanding operating agreements vs bylaws can be challenging, Nicole Pavlik Law Firm is here to help. Contact our team today to schedule a consultation and learn more. We specialize in helping entrepreneurs and businesses draft the right documents and can guide you through the process.