What Is an LLC Operating Agreement? - How to Start my LLC

What Is an LLC Operating Agreement?

Written by:

Carolyn Young has over 25 years of experience in business in various roles, including bank management, marketing management, and business education.

Reviewed by: Sarah Ruddle

For over 15 years, Sarah Ruddle has been a noteworthy leader in the business and nonprofit world.

What Is an LLC Operating Agreement?

What Is an LLC Operating Agreement?

If you’re starting a business and forming an LLC, most states do not require an operating agreement, but it’s best to have one in your records. 

An operating agreement is particularly important if your LLC has more than one owner, or member, as it establishes ownership percentages, profit and loss distribution, and member roles and responsibilities. 

Why You Need an Operating Agreement

A smartly drafted operating agreement can help you in many situations, such as when your LLC merges with another business or when a member can no longer work.

The operating agreement establishes members’ ownership share in the LLC, profit, and loss distribution percentages, and how proceeds will be divided if the business is sold. An operating agreement also defines how decisions are made and potential disputes between members resolved. 

It also defines each member’s role and responsibilities and how the LLC is managed, clarifying who does what and oversees various aspects of LLC operations. 

Without an operating agreement, laws will apply by default, and disputes may have to be settled in court, which can have serious negative consequences for the business.

What Should the Operating Agreement Include?

Again, the operating agreement will define members’ ownership percentages and how profits and losses are distributed. Those are its most important elements, but it should also include the following:

Membership Information:

  • Each member’s rights and responsibilities: This section should outline the scope of authority, duties, and responsibilities that each member has in the company.
  • Capital contribution requirements for each member: Specify the amount or value each member contributes to the LLC and what they receive in exchange (usually a percentage ownership).
  • Procedures for adding and removing members: Describe the process for bringing in new members or removing existing ones. This could include buy-in or buy-out clauses and state-specific legal requirements for admission of new members.
  • What happens when a member sells their interest, becomes disabled, or dies: Address procedures like right of first refusal, buyout terms, or potential successor members.
  • Conditions under which a member might become bankrupt or insolvent: Determine how the LLC will respond in such situations. For instance, the LLC might have the right to buy out the insolvent member’s interest.

Management and Voting:

  • Management structure and roles of members: Define whether the LLC is member-managed or manager-managed and specify roles and duties accordingly.
  • Voting rights of each member: Clarify whether voting rights are proportional to ownership percentage or if there are other arrangements.
  • Rules for meetings and voting: Set forth guidelines for conducting meetings, including notice requirements, quorum, and state-specific voting rules.
  • Rules for managing potential conflicts of interest among members: This could include disclosure requirements and procedures for handling conflicts.

Financial Matters:

  • Allocation of profits, losses, and distributions: Generally, it’s based on ownership percentages, but other arrangements can be made.
  • Provision for periodic financial audits or reviews: Decide on how often the company’s finances will be audited or reviewed.
  • Tax treatment of the LLC: LLCs default to pass-through taxation, but members may elect corporate taxation.

Changes and Amendments:

  • Process for amending the operating agreement: Outline how members can propose and vote on changes.
  • Guidelines for company management during transition events: Specify steps the LLC should take during major changes, like mergers or acquisitions.
  • Conditions under which the LLC might be sold or merged: Describe scenarios and processes for selling or merging the LLC.

Disputes, Legalities, and Policies:

  • Clauses for dispute resolution or mediation: Propose procedures like mediation or arbitration before litigation in state courts.
  • Guidelines for non-compete and confidentiality agreements: Detail the expectations around proprietary information and restrictions on members’ business activities.
  • Provision for indemnification and limitation of liability: Specify the conditions where members might be indemnified by the LLC.

Record Keeping and Communication:

  • Details about record keeping requirements: Align with the state’s record-keeping statutes and ensure that members have access to essential documents.
  • Guidelines for how company-related decisions will be documented or communicated: State whether decisions are documented in meeting minutes, written consents, or other forms.

Company Information and Dissolution:

  • Description of the business’s purpose and activities: Clearly describe the company’s business activities.
  • Identification of the registered agent and office: The LLC must have a registered agent and office in the respective state.
  • Procedures for dissolving the LLC: Describe the steps for dissolving the LLC as per state law.
  • Procedures for winding down or liquidating the company’s assets: Outline how assets will be distributed among members upon dissolution.

How to Draft an Operating Agreement

You can find operating agreement templates online from services like ZenBusiness, which will provide standard legal lingo and allow you to fill in the blanks. You’ll probably be able to find free templates online as well, but it’s advisable not to use those. It’s best to stick with a professional service.

Consider having an attorney draw up your operating agreement if your business has multiple members. An attorney will ensure that all bases are covered, and all member’s rights are protected. They can also include language that is specific to your state’s laws. 

This could cost anywhere from $250 to $2,500, but having a professional’s expert help is well worth it.

 

Access our complimentary operating agreement templates for your use. Choose the single-member LLC version if you’re the sole owner, or opt for the multi-member LLC template if your company has several members. Customize these documents to conform to your state regulations and specific business requirements. Designed for private management, these templates do not need to be filed with any official agency.

Download FREE Operating Agreement Templates

Disclaimer: These documents might require modifications to suit your specific needs and may not encompass every scenario. As your business grows and changes, updates to your document may be necessary. These documents are not intended as legal counsel. We strongly recommend having your tailored document reviewed by a legal professional to ensure it contains all the necessary provisions for your unique business circumstances.

Articles of Organization vs. Operating Agreement

The operating agreement should be distinct from the articles of organization for your LLC. The articles of organization officially form your LLC with the state and include no information about member roles or financial interests. 

Also, the articles of organization are filed with the state and part of the public record, while an operating agreement is kept in your LLC’s records and referred to as needed. 

Keep Your State Operating Agreement Up to Date

It’s a good idea to review your operating agreement periodically. Circumstances change, and it’s wise to ensure your operating agreement is up-to-date on all relevant laws. Generally, your operating agreement will state that members have to vote to approve amendments to the operating agreement. 

Don’t Skip the Operating Agreement

Even though you’re not required to have an operating agreement in most states, the smart entrepreneur will not start doing business without one. It’s a document that may be critical to the future of your business. 

You may think a dispute will never arise, but times and people change. You don’t want to end up in a bitter court battle because you pushed off creating an operating agreement. It’s a document that will protect the rights and interests of all your LLC members and ensure smooth, continued operations in the event of any unexpected hurdles or pitfalls.