Do You Need An Operating Agreement For An LLC?

The formation of a new business entity can be both exciting and frustrating. The complex interplay of state and federal laws, industry regulations, and local licensing requirements can make it difficult to determine which business structure offers the most appropriate balance of liability protections, business owner flexibility and autonomy, and options for future business growth. A Limited Liability Company (LLC) structure is one of the most popular choices for solo entrepreneurs as well as for small group startup businesses, for a number of reasons – but the efficiency and longevity of these businesses can often be impacted by the terms of their operating agreements. If you are preparing to register a new business in Arizona, consider scheduling a consultation with Harrison Law, PLLC to discuss some of the main terms to include in the operating agreement for an LLC.  Call (480) 320-2310 today to be connected with a member of our team.

Types of Business Structures

According to the United States Small Business Administration (SBA), the “structure” under which a business is organized has implications for how the business’s taxes are handled, the degree to which the owner’s or co-owners’ personal assets may be at risk, and a variety of other considerations. The SBA also explains that in most cases a business’s founder or founders will choose its structure when registering the business with the appropriate authority.

This state-centered approach to business formation can mean that not all of the federally recognized business structures are available in every state, and the legal requirements for forming a business under any particular structure can differ, depending on state laws, with the Internal Revenue Service (IRS) noting that LLC formation may not be an option in all locations. However, LLCs are among the most common business structures, and they are certainly an option for many Arizona entrepreneurs to consider. Understanding how LLCs fit within the framework of other business structures can make it easier to understand both how the operating agreement for an LLC works and whether forming an LLC in Arizona makes sense for your business.

Sole Proprietorship

A sole proprietorship may in some ways be the simplest type of business to form, because starting a sole proprietorship does not require filing with the Secretary of State or other regulatory agency. Sole proprietorships are “unincorporated” business structures, which means that the business is not formed as a separate entity for legal and taxation purposes.

The simplicity of a sole proprietorship business structure makes it an attractive option for many individuals operating on their own, particularly for entrepreneurs managing the initial stages of their business start-up as a side-venture. However, a sole proprietorship comes with heavy financial risks, as it is considered a “pass-through” structure by the IRS and the sole proprietor is generally held personally responsible for any liabilities incurred by the business.

Partnership

A partnership is an unincorporated business structure involving two or more co-owners, who may share the liability risk and potential rewards in a number of different ways, depending on how the partnership is organized (structured). 

Arizona recognizes three distinct types of partnership business structures, according to the office of the Arizona Secretary of State (SoS). All partnership businesses in Arizona are subject to the rules set out in A.R.S. Title 29 and formed through registration with the Arizona Secretary of State.

Limited Liability Company

In Arizona, both corporations and LLCs are registered through the Arizona Corporation Commission (ACC). For LLCs, the new business formation process requires submitting articles of organization, meeting the criteria set out in A.R.S. § 29-3105, to the ACC. The ACC then reviews the submitted documents to ensure statutory compliance; limited liability companies whose initial articles of incorporation do not meet the specified requirements may find that they must submit additional or amended documents.

Some entrepreneurs may elect to form single-member LLCs in order to reduce their potential liability risks. An LLC operated by a single member is not treated as a sole proprietorship for IRS tax purposes if the owner-operator elects to treat the LLC as a corporation.

Corporations

The word corporation is linked to the same root word as “corpus” (body) and “corporeal,” and incorporation is the legal process by which a business with multiple shareholders is established a single, discrete “body,” or legal entity, so that the business can operate as a person for purposes of engaging in financial transaction, filing and responding legal actions, and so on. Corporations do confer many benefits similar to those offered by limited liability companies in terms of risk management, but they are subject to distinct federal tax rules, which vary depending on the type of corporation.

Like LLCs, corporations in Arizona are registered through the ACC, rather than with the Secretary of State’s office. Entrepreneurs wishing to form a corporation in Arizona will submit articles of incorporation, which serve functions broadly similar to the articles of organization submitted by LLCs.

What Is an Operating Agreement?

Under A.R.S. § 29-3105 (2023), the operating agreement for an LLC covers:

• The responsibilities and authority of an individual identified or serving in the capacity of the LLC’s manager
• The scope of the company’s business activities and how they will be carried out
• The individual rights and mutual responsibilities of the LLC’s members
• The nature and terms of the relationship between the members and the company

A.R.S. § 29-3102.17 defines as an operating agreement any agreement, whether written or oral, and irrespective of whether the agreement is formally recorded, that fulfills the functions of the operating agreement for an LLC outlined in § 29-3105. In that sense, any LLC that operates on the basis of an agreement among its members has an operating agreement under Arizona law.

Benefits of a Formal Operating Agreement for an LLC

When new business founders or entrepreneurs have questions about the operating agreement for an LLC, they most often have in mind a formal, written document signed by each of the members. Registering an LLC in Arizona does not require this type of formal operating agreement, relying instead on the company’s articles of organization. However, creating a clearly-worded operating agreement can be an important step toward protecting the business, as well as its members.

The priorities to be weighed in consideration will differ somewhat from one business to the next, but in general a carefully-drafted LLC operating agreement can help by:

• Outlining the responsibilities of each member toward the company and the other members
• Delineating the terms under which new members may or may not be added to the organization
• Establishing clear guidelines for the actions each member is, or is not, authorized to take on behalf of the company without consulting the other members
• Laying out the circumstances under which consensus among the members is required before taking a business action, and how disagreements among the members will be resolved

A business law attorney with Harrison Law, PLLC, may be able to help your organization draft an effective operating agreement for your limited liability company.

Matters Not Covered by an Operating Agreement

One major reason for creating a formal, written operating agreement for an LLC is that Arizona Title 29 applies its own provisions to matters not explicitly covered in a company’s operating agreement. When the operating agreement is a written document signed by all of the company’s members, it is generally much easier to show, if the need arises, whether a specific issue is covered in the agreement. A.R.S. § 29-3105(A)(3) specifies that in a conflict between Chapter 3105 and a provision in the operating agreement for an LLC with respect to relations among the members or between the members and the company, the operating agreement prevails. This priority of application confers substantial power on an LLC for the management of its own internal affairs. A.R.S. § 29-3105(B) further explains that for any issue covered in subsection A of the chapter (broadly, relations among members and between members and LLC) that the operating agreement for an LLC fails to address, the guidelines set out in Chapter 3105 will apply. In other words: Limited liability companies may forfeit considerable self-governing prerogative if they neglect to create thorough, thoughtful operating agreements that account for multiple eventualities.

Speak With an Arizona Business Law Attorney Today To Learn More About Your Legal and Financial Rights

If you are considering the formation of a limited liability company in Arizona, you may have a number of questions pertaining to drafting the operating agreement for an LLC. These documents can be crucial to ensuring both company longevity and the smooth running of everyday business tasks and decisions. An Arizona business law attorney with Harrison Law, PLLC may be able to help you evaluate the key terms and specifications to include in an operating agreement as you prepare to register your business with the Arizona Corporations Commission. Schedule a consultation with a member of our team by calling (480) 320-2310 today.

© 2024 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.