When you're starting a business, you have to think about the boring stuff.
There are legal decisions to make. There are forms to complete. Although the paperwork can seem overwhelming, these documents are essential to keeping your operation running smoothly.
One of the common questions new small business owners have concerns articles of information vs. operating agreements. What’s the difference?
Articles of incorporation and operating agreements both outline the structure of a business and define its ownership. But each of these documents serves a unique purpose, and small business owners and real estate investors often mix them up or think they are the same thing.
To help you understand which document you need for your business—or if you need both—we'll examine the characteristics of each one, including their similarities and their differences. Don't be bored ... Getting this right on the first try will increase your chance of success down the road.
Articles of incorporation (also called a corporate charter or a certificate of incorporation) is a set of legal documents that establishes a corporation in the eyes of the state. These documents, which are typically filed with the secretary of state, give the business owner asset protection by separating personal assets from the business assets.
The information included in your articles of incorporation can vary according to the nature of your business and your state's requirements. However, these documents generally include the following elements:
If you are filing for incorporation as an LLC, you are not legally required to have articles of incorporation. However, if your business is an S or C corporation, you must file these documents with your state.
An operating agreement is a legal document that establishes internal operating procedures and defines the business relationship between the members (owners) of a limited liability company (LLC). All LLCs with two or more members should have an operating agreement to protect the business' LLC status, clarify verbal agreements in writing, and legally protect the agreement in the eyes of your state.
An LLC operating agreement should include the following elements:
Although not all states require Series LLC operating agreements, legal experts recommend having a written agreement (or bylaws) that outlines your business operations. In addition to helping your business run more smoothly, some financial institutions will require corporate bylaws before you can open an account or get a loan.
One way to look at the difference between these two legal documents is that articles of incorporation define a business as a corporation with the state, while an operating agreement defines how the business owners relate to each other. Therefore, the first one is a public document, while the second is more for internal use.
Another difference is operating agreements are often less formal than articles of incorporation and therefore are usually easier to update and adjust as the organization changes and grows.
Articles of incorporation and operating agreements both outline your business structure and share some similar features. Both documents contain basic business information, such as its name, purpose, management structure, and how it will operate.
Another thing the documents have in common is that they both can contribute to the successful operation of a small business.
Both articles of incorporation and operating agreements require wording that is specific to your business, your state's requirements, and your type of operation. Vague or general verbiage can create problems down the road.
For example, here are some problems to guard against in your legal documents:
An experienced legal professional can answer questions and provide help with operating agreements or articles of incorporation. The bottom line is that while these documents can be a headache to prepare when you are launching your new business, you will be glad later that you took the time to do them right.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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