Understanding Different Types of Business Agreements: Operating Agreements, Partnership Agreements, and Bylaws
Establishing a business is an exciting endeavor, but it comes with the responsibility of creating a solid legal foundation for the entity’s operations, governance, and relationships among its owners and stakeholders. Central to this foundation are business agreements—binding documents that define how a company is structured, managed, and run. Whether the business is a limited liability company (LLC), partnership, or corporation, the right agreement is essential for clarity, operational efficiency, and legal compliance.
This guide explores three of the most common and crucial business agreements: operating agreements, partnership agreements, and bylaws. Each serves a unique purpose, depending on the business structure, and understanding their differences is vital for entrepreneurs, executives, and investors alike.
Importance
While some states do not require LLCs to have an operating agreement, having one is highly recommended. It helps prevent disputes by clarifying expectations and responsibilities and is often necessary to open business bank accounts or secure financing. In the absence of an operating agreement, state default laws will govern the LLC, which may not reflect the members’ intentions.
Customization and Flexibility
One of the greatest advantages of an operating agreement is its flexibility. Members can tailor it to fit the unique structure and goals of their business, unlike corporations that must adhere to more standardized bylaws. This flexibility makes the operating agreement a powerful tool for ensuring the LLC operates according to the owners’ vision.
Partnership Agreements
A partnership agreement is the foundational contract between two or more individuals who wish to carry on a business together as partners. This document sets out the terms of the partnership, the relationship of the partners, and how the business will be run.
Partnership agreements are used in general partnerships, limited partnerships (LPs), and limited liability partnerships (LLPs). While not always legally required, such agreements are crucial for avoiding misunderstandings and providing mechanisms for resolving disputes.
Key Components
Partner Contributions: Specifies the cash, property, services, or other assets each partner will contribute to the partnership.
Profit and Loss Distribution: Details how profits and losses will be divided among partners, which can be equal or based on contributions or another agreed formula.
Roles and Responsibilities: Outlines the duties of each partner, including management rights, scope of authority, and any restrictions.
Decision Making: Sets forth how major and day-to-day decisions will be made, including voting procedures and tie-breaking mechanisms.
Admitting New Partners: Establishes the process for adding new partners and the requirements for their admission.
Withdrawal or Exit: Explains how a partner may voluntarily leave the partnership, as well as what happens in case of death, disability, or expulsion.
Dispute Resolution: Provides methods for resolving disagreements, such as mediation or arbitration, to avoid litigation.
Types of Partnership Agreements
General Partnership: All partners share management, profits, losses, and liability equally unless otherwise specified in the agreement.
Limited Partnership (LP): Has both general partners (who manage and are liable) and limited partners (who have limited liability and typically do not manage).
Limited Liability Partnership (LLP): All partners have limited liability, protecting their personal assets from the debts of the partnership.
Importance
Without a written partnership agreement, the partnership will be governed by default state laws, which may not reflect the partners' wishes or best interests. An agreement provides certainty and helps prevent costly disputes by clearly addressing common and uncommon scenarios.
Bylaws
Bylaws are the internal rules adopted by a corporation to govern its operations and management. Unlike operating agreements or partnership agreements, which apply to LLCs and partnerships, bylaws are specific to corporations—both for-profit and nonprofit.
The bylaws serve as an operating manual specifying how the corporation will be run, the roles and responsibilities of directors and officers, and the procedures for important corporate actions.
Key Components
- Board of Directors: Describes how directors are elected, their terms of service, and procedures for removal or replacement.
- Officers: Specifies the officers’ roles (such as president, secretary, treasurer), duties, and manner of selection or removal.
- Shareholder Meetings: Sets guidelines on when and how meetings are held, including annual and special meetings, and the notice required.
- Quorum and Voting: Defines what constitutes a quorum for meetings and how voting will occur for directors, officers, and shareholders.
- Committees: Provides for the creation and function of board committees, such as audit or compensation committees.
- Record Keeping: Outlines requirements for maintaining minutes, records, and other corporate documents.
- Conflict of Interest: Includes policies to manage potential conflicts among directors, officers, and shareholders.
- Amendment Procedures: Details how bylaws may be amended, repealed, or adopted.
Adoption and Legal Status
Bylaws are typically adopted during the corporation’s first organizational meeting by its initial board of directors or incorporators. They do not need to be filed with the state but must be kept with the corporation’s official records.
While bylaws are not usually required by state law to be made public, they are legally binding on the corporation’s directors, officers, and shareholders. They are essential for conducting business, opening corporate bank accounts, and demonstrating the company’s organizational legitimacy.
Importance
Bylaws help ensure transparency, consistency, and accountability within the corporation. They guide day-to-day operations and provide structure for decision-making, thereby reducing the risk of internal disputes and legal challenges.
Comparative Summary
Operating agreements, partnership agreements, and bylaws serve similar purposes—establishing the framework for how a business is run, how decisions are made, and how disputes are managed. However, each is tailored to a specific business entity:
- Operating Agreements: Used by LLCs; highly flexible and customizable; addresses members’ rights, management, profit-sharing, and dissolution.
- Partnership Agreements: Used by partnerships; outlines contributions, management, profit/loss sharing, dispute resolution, and dissolution; applies to various forms of partnerships.
- Bylaws: Used by corporations; governs the board of directors, officers, meetings, committees, and shareholder relations; ensures compliance with state laws and corporate practices.
Choosing the right agreement and tailoring it to the particular needs of the business is paramount for fostering collaboration, ensuring smooth operations, and protecting the interests of all parties involved.
Conclusion
Every successful business begins with a solid legal foundation. Whether you are forming an LLC, partnership, or corporation, the appropriate governing document—operating agreement, partnership agreement, or bylaws—is indispensable. These agreements help define roles, manage expectations, and create a roadmap for resolving disputes and addressing unforeseen circumstances.
It is advisable to consult with legal professionals when drafting these documents to ensure compliance with relevant laws and to create agreements that reflect the true intentions and best interests of the parties involved. By investing time and attention in clear, comprehensive business agreements, entrepreneurs and stakeholders lay the groundwork for long-term success and sustainable growth.
