Articles of Incorporation Vs. Operating Agreement: What's The Difference?

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.

Bored? Don't be. A profitable business is exciting!

What are articles of incorporation?

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:

• Legal name and address of the business
• Date business was established
• Business purpose
• Business bylaws
• Names of the business owners
• Name and address of the registered agent
• What share of ownership can be held by investors
• What restrictions are placed on business activities

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.

What is an operating agreement?

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:

• Description of the business operations
• The succession plan if an owner exits or an unexpected issue occurs with an owner
• How managers are appointed, their responsibilities, and obligations
• How members vote on important issues
• How the transfer of ownership occurs
• How profits, losses, and distributions are handled
• How records are maintained
• Other information members feel is necessary

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.

How do articles of incorporation and operating agreements differ?

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.

How are articles of incorporation and operating agreements similar?

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. 

How do you write articles of incorporation or an operating agreement?

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:

• Not defining decision-making powers. Be sure to specify what decisions need to be unanimous among the members and which ones can be made by a majority. Also, clarify what constitutes a majority.
• Not being specific on manager selection. Use precise language on how managers are elected or removed. If voting occurs, spell out who is eligible to vote on managers.
• Not keeping the manager's powers in check. Spell out the exact duties of the manager to prevent possible abuse of power. Clearly state how and when company assets may be sold, including when a vote is needed on these decisions.

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.

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