What Is an S Corp Operating Agreement?
An operating agreement is a contractual document that lays out how a business is structured and how it is to conduct important activities. This includes how it’s owned and operated and how its profits are to be distributed.
It is designed to document the policies and rules that govern the internal operations of the business so that members and employees are aware of what they are and to ensure that “everyone is on the same page.” Specifically, an operating agreement is meant to:
- avoid internal dissension by documenting important policies and rules
- override default legal rules
- preserve limited liability status
An S corp operating agreement is one created specifically to govern the operations of a regular corporation (C corp) or LLC that elects to be taxed under subchapter S of the Internal Revenue Code.
For more information, see our guide What Is an LLC Operating Agreement?
To ensure you benefit from these advantages, as well as to steer clear of complications in the future, your S corp should not only have an operating agreement that ensures the business is run smoothly but makes its tax status clear by using the appropriate terms.
Why Have an Operating Agreement?
There are several reasons for an LLC or S corp to have an operating agreement. In particular, an operating agreement is critical for:
- Documenting Important Policies and Rules
- Overriding Default State Legal Rules
- Preserving Limited Liability Status
Documenting Important Policies and Rules
An operating agreement clarifies important policies and rules for running the company. These include aspects covering ownership, profit distribution, and the roles and responsibilities of owners.
Additionally, an operating agreement can clarify verbal agreements. Even if members have orally agreed to certain terms, misunderstanding or miscommunication can take place.
It is always best to have the operational conditions and other business arrangements handled in writing so they can be referred to in the event of any conflict.
Overriding Default State Legal Rules
State default rules govern LLCs without an official operating agreement. This means that each state outlines default rules that apply to businesses that do not sign operating agreements.
Because the state default rules are so general, it is not advisable to rely on a governing body state to manage your agreement. To maintain adequate control over how your company is run, you need to draft your own operating agreement.
Preserving Limited Liability Status
As its name implies, an LLC offers limited liability protection for its members. This means that members’ personal assets will not be used to satisfy the LLC’s financial obligations, such as debts or legal judgments.
An operating agreement helps reinforce this liability protection. Without this specific formality, your LLC can closely resemble a sole proprietorship or partnership which could lead to personal liability.
How to Write an Operating Agreement
Article II: Management and Voting
This section addresses how the company is managed and how the members vote.
- An LLC can be managed by the members or by one or more managers that are appointed by the members. The operating agreement specifies the members’ or managers’ specific authority.
- If the company allows votes on business decisions, this section describes how votes are allocated among members. This could include, for example, one vote per member or one vote per unit of ownership interest. The operating agreement also may indicate how many votes are needed for specific company actions.
These are not the only topics an operating agreement may address. Other topics that members might want to address include meeting requirements, check signing requirements, and dispute resolution procedures.
Keep in mind that once you start a business, your operating agreement can be updated at any time through a process of your choice.
Our Free LLC Operating Agreement Template will help you write your LLC’s operating agreement.
Converting an LLC Operating Agreement to S Corp
To convert an LLC operating agreement to an S corp operating agreement, take the following steps.
Add Shareholder Minutes
Corporations are usually required to take minutes at meetings, so an S corp operating agreement needs to explain how this will occur.
Review Your State and Company Shareholder Voting Rules
In addition, shareholders in an S corp have voting rights in the company. Every state has different rules about how shareholder voting should be conducted, and these should be reflected in the S corp operating agreement, along with any other rules the company establishes.
File Your Amended S Corp Operating Agreement if Necessary
Some states require S corps to file amended operating agreements. Review the rules in your state, and file your amended S corp operating agreement if necessary.
S Corp Operating Agreement Frequently Asked Questions
Why do I need an S Corp Operating Agreement?
An S corp operating agreement explains how a business is structured, how it conducts important activities, how it is owned and operated, and how its profits are to be distributed.
Although most states don’t require an operating agreement for an LLC — except for California, Delaware, Maine, Missouri, Nebraska, and New York — one is highly recommended to avoid misunderstandings and make sure all the owners understand and agree to key aspects of the business.
Are operating agreements public record?
Unlike the Articles of Organization, an LLC or S corp operating agreement is not public record.
What is the difference between an operating agreement and bylaws?
An LLC’s or S corp’s operating agreement and corporate bylaws have similar purposes. A key difference is that bylaws don’t name individual members of a corporation’s board of directors, whereas an LLC’s or S corp’s operating agreement does name the company’s owners.