What Is The Difference Between an Operating Agreement and Bylaws?

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When starting a business, there are many legal documents that need to be considered and drafted. Two of the most important documents for any business entity are the operating agreement and the bylaws. 

These documents outline the internal structure and governance of the business, but they serve different purposes and have distinct characteristics. In this article, we will explore the differences between an operating agreement and bylaws to help you understand their roles in your business.

The Operating Agreement

An operating agreement is a legal document that outlines the ownership and operating procedures of a limited liability company (LLC). It is a crucial document for LLCs as it defines the rights and responsibilities of the members, the financial and managerial structure, and the distribution of profits and losses.

Purpose and Content

The primary purpose of an operating agreement is to establish the internal rules and regulations of an LLC. It governs the relationship between the members and provides a framework for decision-making processes and dispute resolution. The agreement typically includes provisions related to:

  1. Ownership and Membership: The operating agreement specifies the ownership percentage of each member and their voting rights. It also outlines how new members may be admitted or existing members may transfer their ownership interests.

  2. Management and Decision Making: It defines the management structure of the LLC, whether it is member-managed or manager-managed. It outlines the roles and responsibilities of managers and members, procedures for decision-making, and the authority to bind the company.

  3. Distributions and Allocations: The operating agreement details how profits and losses will be allocated among the members. It establishes the rules for distributing profits and the order of priority for distributing assets upon dissolution.

  4. Amendments and Dissolution: The agreement should include provisions for amending the agreement itself and procedures for dissolving the LLC.

Flexibility and Customization

One significant advantage of an operating agreement is the flexibility it offers. Unlike bylaws, which are required for corporations, an operating agreement is not mandatory in all states. However, it is highly recommended as it allows business owners to customize the internal rules and structure of their LLC to fit their specific needs.

The operating agreement provides a great deal of flexibility in terms of decision-making, management structure, and profit distribution. It allows members to establish their own rules and procedures, providing a tailored framework for running the business efficiently. This flexibility is particularly valuable for small businesses with a limited number of owners who desire more control over the internal operations.

The Bylaws

Bylaws, on the other hand, are a set of rules and procedures that govern the internal operations of a corporation. They are mandatory for corporations and serve as the guiding document for the corporation’s directors, officers, and shareholders.

Purpose and Content

The primary purpose of bylaws is to establish the corporate governance structure and provide a roadmap for how the corporation should be managed. While the specific content of bylaws may vary depending on the state and the corporation’s needs, they typically include provisions related to:

  1. Board of Directors: Bylaws outline the number of directors, their qualifications, terms of office, and how they are elected or appointed. They also define the powers and responsibilities of the board.

  2. Shareholders: Bylaws specify the rights and obligations of shareholders, including their voting rights, procedures for annual meetings, and how to call special meetings.

  3. Officers: They define the roles and duties of officers, such as the CEO, CFO, and Secretary. Bylaws also outline the process for electing or appointing officers and their terms of office.

  4. Amendments and Dissolution: Bylaws include provisions for amending the bylaws and procedures for dissolving the corporation.

Legal Requirement and Formality

Unlike an operating agreement, which is optional in some states, bylaws are mandatory for corporations. They are a legal requirement and must be adopted and regularly updated to ensure compliance with state laws. Bylaws provide a formal structure for the corporation’s governance and serve as evidence of the corporation’s internal regulations.

Furthermore, bylaws are subject to more formalities compared to an operating agreement. They are typically adopted by the board of directors and may require shareholder approval. Bylaws are often publicly filed as part of the corporation’s formation documents and are accessible to shareholders, potential investors, and regulatory agencies.

Conclusion

In summary, both the operating agreement and bylaws are important legal documents that dictate the internal structure and governance of a business entity. While an operating agreement is specific to LLCs and offers flexibility and customization, bylaws are mandatory for corporations and provide a formal framework for corporate governance.

Understanding the differences between these documents is crucial for business owners. It is essential to consult with legal professionals or experienced business advisors to draft appropriate operating agreements or bylaws that align with the specific needs and legal requirements of your business. By doing so, you can establish a solid foundation for your business’s internal operations and ensure compliance with state laws and regulations.

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