An operating agreement is the internal contract among the owners of a limited liability company. It establishes who owns what percentage of the business, who has the authority to make decisions and sign on the company's behalf, how profits and distributions are divided, how disputes between owners are handled, and what happens when an owner joins, leaves, passes, or wants to be bought out.
It is best practice to have an operating agreement in place for most businesses. Although Indiana does not legally require an LLC to adopt an operating agreement, if you do not have a written one, Indiana's default statutory rules under the Indiana Business Flexibility Act, found at Indiana Code Title 23, Article 18, will decide those questions for you. An operating agreement allows you to keep control over the how your business is managed and governed.
This article explains what an operating agreement is, when you might want to have one in place, and what is included in most operating agreements.
What is an operating agreement?
An operating agreement is the private governing document of a limited liability company. The owners of an LLC are called members, and the operating agreement is the contract those members enter into with each other and with the company itself.
Think of it as the rulebook the owners write for themselves. A contract with a customer governs your relationship with that customer. A lease governs your relationship with your landlord or tenant. The operating agreement governs the relationship among the owners, and it is the document a court, a lender, a title company, or a potential buyer will ask for first when they need to know who actually controls the business.
It is also the only place where certain decisions can be made at all. Indiana's LLC statute supplies a default answer to most governance questions and then permits the owners to choose a different answer. For many of those provisions, the statute allows a different answer only if the members have adopted a written operating agreement.
What does an operating agreement actually do?
A well drafted operating agreement performs four distinct jobs.
It allocates ownership and capital accounts. The agreement states each member's ownership percentage, records what each member contributed and the agreed value of that contribution, establishes how profits and losses are allocated among the members, and sets out when and how distributions are paid.
It assigns authority. The agreement identifies who makes ordinary day to day decisions, which decisions require a supermajority or unanimous approval, who may act on behalf of the company, and what limitations there may be in actions that can be taken on behalf of the company.
It governs exits. The agreement covers transfers of membership interests, may establish buyout provisions that trigger on death, disability, divorce, bankruptcy, voluntary withdrawal, or removal, and can set out how a departing member's interest is valued.
It documents separateness. A written agreement that the owners follow is evidence that the LLC is a genuine entity distinct from the people who own it, which can strengthen the liability protection offered by an LLC.
How is an Operating Agreement Different from the Articles of Organization?
The Articles of Organization creates the LLC as a legal entity. You file them with the Indiana Secretary of State through their online e-filing platform, pay a filing fee, and they become part of the public record when approved by the Secretary of State’s office, which typically takes one business day. The Articles of Organization states the company's name, its registered agent and registered office, general information about its governing person, and whether the company is managed by its members or by one or more managers. Once the Secretary of State accepts the filing, your LLC exists.
The Operating Agreement governs how that entity actually runs. You do not file it with anyone, rather it is an internal document for your company that lives in your company records. You may occasionally be requested to produce it when a bank, a lender, a title company, a court, or a buyer asks to see it. The operating agreement is referenced by a business to provide clarity on how profits and losses are handled, how decisions are to be made, and other organizational questions that often arise in a business.
What if my Business is not an LLC?
The same concept exists for other entity types under different names.
A corporation, including a corporation that has elected S corporation tax treatment, is governed by its bylaws. If the corporation has more than one shareholder, it may also have a shareholder agreement, which performs many of the same functions an operating agreement performs for an LLC.
A general or limited partnership is governed by its partnership agreement, which can be in the form of an operating agreement.
A sole proprietorship has no governing document because there is no separate entity to govern. That is one of several reasons sole proprietorships are a poor fit for most businesses that have any meaningful liability exposure, as the sole proprietor is personally liable for any liabilities of the company.
Is an Operating Agreement Legally Required?
In Indiana, no. The Indiana Business Flexibility Act imposes no obligation to adopt an operating agreement, and there is no filing requirement. Your LLC exists the moment the Secretary of State accepts your Articles of Organization, with or without an operating agreement in place.
Member Managed or Manager Managed
Every LLC is one or the other, and the choice determines who has authority to run the business. This decision is made when you file your articles of organization and shapes how the operating agreement is drafted.
In a member managed LLC, the owners run the company themselves. Each member generally has authority to act on the company's behalf, and ordinary decisions are made by the members voting together. In a manager managed LLC, the members appoint one or more managers to handle day to day operations, and the members step back into an ownership role rather than an operational one. A manager does not have to be a member, which makes this structure useful when the company has passive investors, when ownership is spread across a larger group, or when the owners want a single point of signing authority for lenders and vendors.
When Your Business May Need an Operating Agreement
When your LLC has More than One Owner
In these instances, an operating agreement is strongly encouraged. Partnerships can unexpectedly collapse at any time due to ordinary friction involved in running a business. One owner works nights and weekends while the other works ten hours a week. One wants to reinvest every dollar and the other wants distributions. One is ready to sell and the other is not. One brings a spouse into the business and the other objects.
A written agreement does not prevent disagreement. What it provides is an agreed process for resolving disagreement, drafted at a time when everyone was still cooperative and nobody knew which side of the question they would eventually be on.
When you are the Sole Owner
Single member LLC owners skip this step most often, but there are several reasons why would still should consider having an operating agreement.
The first is reinforcing the liability shield. One prominent purpose of forming an LLC to conduct business activities is to separate business liability from your personal liability. If a creditor or a plaintiff argues that the LLC is really just you operating under a different name, the question becomes whether you treated the company as a genuinely separate entity. A written operating agreement that you actually follow becomes part of that record, although it is not dispositive.
The second is that many third parties ask for it. Banks, SBA lenders, commercial landlords, title companies, and payment processors often request operating agreements as a matter of routine underwriting.
The third is continuity. An operating agreement can name who succeeds to your membership interest and who has authority to sign in the interim. Without it, your interest passes through your estate, and your family may be waiting on the probate process while payroll, rent, and vendor invoices come due.
When Owners Contributed Unequally
Different cash amounts. One member contributing equipment, real estate, a customer list, or intellectual property. One member contributing full-time labor instead of capital. All of this needs to be documented, including the agreed value assigned to non-cash contributions, because that agreed value is exactly what will determine future distributions.
When Some Owners Work in the Business and Others Do Not
Active and passive owners need different terms. Does the working owner draw a salary, and is that salary separate from distributions? May a passive investor vote on hiring, pricing, or vendor selection? What happens if the working owner stops working but keeps the ownership interest? Silence on these questions can cause problems for businesses with passive and active owners.
When you are Taking on a Partner, an Investor, or an Employee with Equity
Every change in ownership should be documented at the time it occurs. You may need terms covering the admission of new members, dilution of existing members, vesting schedules so that equity is earned over time rather than granted outright, and what happens if the new owner leaves in eighteen months. If you already have an agreement, this is the moment to amend it formally rather than papering over the change with an email.
When the LLC holds Real Estate
Real estate holding companies need explicit terms on capital calls, what happens when a member cannot fund a capital call, authority to refinance, when the property is sold and who makes that decision, and how distributions are handled against depreciation and debt service. Title companies and lenders will want the agreement in their file as well.
When you are in Business with Family, a Spouse, or Friends
Often times, people enter into business with family and friends. While the concept of documenting rules for the business in these types of relationships may seem unnecessary, unforeseen disputes often arise and without an operating agreement, business owners are unsure of how to resolve the matter, and a strain can be placed on personal relationships.
When Owners live in Other States or you Operate Across State Lines
Multi state operations raise questions about which state's law governs, where disputes are resolved, and whether foreign registration is required. Those questions are best resolved in an Operating Agreement.
What a Well Drafted Operating Agreement Covers
A well drafted operating agreement will address the following:
Ownership and capital. Ownership percentages, each member's initial contribution and its agreed value, capital accounts, and whether future capital calls are mandatory or optional.
Management structure. Whether the company is managed by its members or by a manager, stated consistently with the Articles of Organization, along with who holds signing authority and what spending thresholds require approval.
Voting. Which matters are ordinary decisions and which are major decisions, the approval threshold for each category, and a mechanism for breaking deadlock.
Distributions. The allocation formula, the timing of distributions, and mandatory tax distributions so that members have the cash to pay the tax liability that passes through to them.
Tax matters. The company's tax classification election, the allocation method, and who serves as partnership representative.
Transfer restrictions. Limits on transferring a membership interest, rights of first refusal, and whether a transferee receives voting rights or only economic rights.
Buyout provisions. The triggering events, including death, disability, divorce, bankruptcy, voluntary withdrawal, and involuntary removal, along with the valuation method and the payment terms.
Member obligations. Confidentiality, expectations regarding time commitment, and noncompetition terms to the extent they are enforceable.
Duties and indemnification. What members and managers owe to the company and to each other, and when the company will indemnify them and advance expenses.
Dispute resolution. Whether disputes go to mediation or arbitration, the venue, the governing law, and whether attorney fees shift to the prevailing party.
Dissolution and winding up. What triggers a wind up, who administers it, and how remaining assets are distributed.
Need an operating agreement drafted, reviewed, or amended?
Shelton Law P.C. regularly works with Indiana small businesses on formation, operating agreements, partnership structuring, and similar matters.
Email matt@sheltonlawpc.com, call or text (317) 804-1495, or fill out a contact form and a response will be provided within 48 hours.
Operating Agreements: Frequently Asked Questions
What is an operating agreement in simple terms?
It is the written agreement among the owners of an LLC covering who owns what, who decides what, how money is divided, and what happens when someone leaves. It is an internal document that you keep in your company records rather than filing with the state.
Is an operating agreement required in Indiana?
No. The Indiana Business Flexibility Act does not require an LLC to adopt one, and it is not filed with the Secretary of State. Indiana's default statutory rules apply wherever your agreement is silent.
Do I need an operating agreement for a single member LLC?
Legally no, practically it is recommended. It reinforces the separation between you and the company, satisfies banks and lenders who routinely request it, and allows you to name a successor to your membership interest.
Can an operating agreement be oral in Indiana?
Yes. Indiana Code 23-18-1-16 recognizes written or oral agreements. However, many provisions of Article 18 permit the members to depart from the default rules only through a written operating agreement, so an oral agreement delivers much less than owners expect.
Do I file my operating agreement with the Indiana Secretary of State?
No. It is an internal document kept with your company records.
Will a bank require an operating agreement to open a business account?
Frequently yes, particularly for multi member LLCs and commonly for single member LLCs as well.
What happens to my LLC if I do not have an operating agreement?
Nothing happens immediately. The company operates under Indiana's statutory defaults, which allocate profits by capital contribution, require a majority in interest for ordinary decisions, and require unanimous consent to admit new members. The problems surface when the owners disagree, when someone wants out, when an owner dies, or in other unforeseen or unclear circumstances.
Does an operating agreement protect my personal assets?
Not by itself. The LLC provides the liability shield. A written operating agreement that the owners consistently follow is supporting evidence that the company has been maintained as a genuinely separate entity, which can matter if someone argues otherwise.
Can I write my own operating agreement?
You can. The risk is that generic templates leave out the provisions that matter most to your particular business and factual situation.
How do I amend an operating agreement?
Under Indiana Code 23-18-4-6, an amendment to a written agreement must be in writing and, unless the agreement provides otherwise, must be approved unanimously by the members. A well drafted agreement sets its own amendment threshold.
What is the difference between the Articles of Organization and the operating agreement?
The Articles create the entity and are filed publicly with the state. The operating agreement governs how the entity operates internally and remains private.
Disclaimer: This article is informational in nature and is not intended to provide legal advice, nor does it create an attorney client relationship. It discusses Indiana law generally and does not account for the facts of any particular business.