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:
- Each member’s rights and responsibilities
- Capital contribution requirements for each member
- Procedures for adding and removing members
- What happens when a member sells their interest, becomes disabled, or dies
- Conditions under which a member might become bankrupt or insolvent
Management and Voting:
- Management structure and roles of members
- Voting rights of each member
- Rules for meetings and voting
- Rules for managing potential conflicts of interest among members
- Allocation of profits, losses, and distributions
- Provision for periodic financial audits or reviews
- Tax treatment of the LLC
Changes and Amendments:
- Process for amending the operating agreement
- Guidelines for company management during transition events
- Conditions under which the LLC might be sold or merged
Disputes, Legalities, and Policies:
- Clauses for dispute resolution or mediation
- Guidelines for non-compete and confidentiality agreements
- Provision for indemnification and limitation of liability
Record Keeping and Communication:
- Details about record keeping requirements
- Guidelines for how company-related decisions will be documented or communicated
Company Information and Dissolution:
- Description of the business’s purpose and activities
- Identification of the registered agent and office
- Procedures for dissolving the LLC
- Procedures for winding down or liquidating the company’s assets
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.
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.