An LLC operating agreement is a legal document that outlines the terms, rules, and structure of a limited liability company (LLC) according to its members’ needs. These documents define the company’s ownership, management roles, profit distribution, and other key operational details.
Not every state requires LLC operating agreements. However, these contracts are useful in clarifying responsibilities, protecting members’ interests, and ensuring the business’s operations run smoothly. In this guide, we’ll review the importance of LLC operating agreements and outline what should be included as required by state laws, as well as for the benefit of your partnership.
Why every LLC needs an operating agreement
LLC operating agreements aren’t mandatory in every state, but they are foundational to running a new business successfully.
First, it’s worth acknowledging the five states that require operating agreements by law: California, Delaware, Maine, Missouri, and New York. Even within this small group, the requirements vary. For instance, in Delaware, Maine, and Missouri, the operating agreement can be oral, written, or implied. New York mandates a written operating agreement that is kept internally but is not filed with the state. Review your state’s rules regarding LLC formation to make sure you’re compliant.
If you plan to start an LLC in any other state, you don’t need an operating agreement, but experts strongly recommend creating one anyway. “The major pros of an operating agreement are that it protects an LLC’s members from the liabilities of the LLC itself, enhances clarity in how the organization is structured and run, and provides flexibility in that it can be adapted to a specific LLC,” wrote Thomson Reuters.
An operating agreement helps you and your partners decide how the business will run. If your LLC doesn’t have an operating agreement, the state’s default laws apply. For example, some states mandate that all members must share profits equally, no matter how much money each member puts in or owns. If you want a different way to share profits or other rules, your operating agreement can set those up.
Operating agreements clarify the business arrangement between multiple members to avoid the risk of future disputes or misunderstandings. “An operating agreement ensures that each LLC member has the same understanding of their rights and responsibilities and agrees to how decisions and disputes should be handled within the business entity,” wrote LegalZoom.
Additionally, LLC operating agreements provide legal protection for members’ personal assets. These agreements formally separate your business and personal property and assets. As a result, any business-related legal challenges won’t impact your personal liability.
If your LLC doesn’t have an operating agreement, the state’s default laws apply. For example, some states mandate that all members must share profits equally, no matter how much money each member puts in or owns.
What sections are included in an operating agreement?
Operating agreements don’t have to be long. The U.S. Small Business Administration recommends covering the following topics:
- The percentage of members' ownership.
- Voting rights and responsibilities.
- The powers and duties of members and managers.
- Distribution of profits and losses.
- Company meetings.
- Buyout and buy-sell rules (the procedures for transferring interest or in the event of a death).
At a minimum, make sure your LLC operating agreement covers the following topics.
Ownership, capital, and voting
Use your LLC agreement to clarify who owns what, how much control each member has, and how capital and voting rights affect company decisions.
Lay out each member’s ownership share in the LLC, usually based on the capital or assets each person contributed. Ownership shares are expressed in percentages. The agreement should also specify who manages the LLC: members or appointed managers and how major decisions are voted on, which establishes clear governance from the get-go.
Capital contributions record how much money, property, or services each member contributes to the LLC, establishing their financial stake in the company. “Each partner may have contributed a certain amount of capital when they started the business, and it's a good idea to record these amounts, as they may influence other factors of the agreement,” wrote LegalZoom. “List the initial capital contributions of each member, which can be in the form of cash, property, or services.”
Finally, establish voting rights, the voting process, and rules for passing resolutions. Typically, voting rights are proportional to ownership percentages, but you can customize these rights for your business. Outline the procedure for adding or removing new members, including how the process affects ownership interests and any other business changes that necessitate votes.
Profit allocations and distributions
Spelling out how the LLC’s profits will be shared and distributed will help avoid any conflict later. “LLCs offer flexibility in how you can split your business profits. While often the percent of profits individual members get is directly related to ownership percentage, you might decide a different arrangement would be appropriate,” wrote SCORE.
Some LLCs determine profit sharing based on responsibilities; for instance, the person who takes on a heavier workload takes more of the profit. The beauty of an LLC is that you can create a profit distribution system that works best for you.
Management roles and transfers
By default, LLCs are considered “member-managed” by state law. This means all members participate in the daily operations and decision-making of the business. However, your operating agreement can set up a manager-managed structure. In this variation, managers (who may or may not be members) handle daily operations, while members focus on broader business decisions.
“A manager-managed LLC can make sense for your business if certain LLC members don’t intend to take part in decision making (typically family members or outside investors),” wrote the Wolters Kluwer law firm. “If the members choose this option, the members will not have a say in ordinary business decisions designed to help achieve your business’s goals.”
Define how the LLC will be managed over time too. Your LLC operating agreement should set rules on how members can sell or transfer their ownership stakes, including restrictions or the right of first refusal for existing members. It’s also useful to create a succession plan for business continuity in the event of the retirement or death of a member.
[Read more: What Is a Limited Partnership?]
State requirements for LLC agreements
As previously stated, only five states require some version of an LLC operating agreement. However, each state has other requirements for forming an LLC.
“Generally, these requirements include selecting a unique business name, appointing a registered agent, and filing Articles of Organization with the appropriate state agency (usually the Secretary of State),” wrote ZenBusiness.
Some entrepreneurs confuse the LLC operating agreement and the articles of organization. Articles of organization are required by states to legally create an LLC. This document contains basic business information, including the LLC’s name, address, registered agent, members/managers, and whether it’s member-managed or manager-managed.
Its primary purpose provides the legal existence of the LLC. Comparatively, the operating agreement governs the internal affairs of the LLC.
Templates for LLC operating agreements
There are dozens of free and paid templates for LLC operating agreements from which to build your own. Look for a template that includes these elements:
- Company formation details, with key information like member names and the principal office address.
- Capital contributions, such as clear descriptions of each member’s initial investment.
- Ownership and profit distribution specifying ownership percentages and how profits and losses are divided.
- The management structure, such as whether the LLC is member-managed or manager-managed, plus the roles and responsibilities for members or managers.
- The voting rights, procedures for meetings, and how ties or deadlocks will be resolved.
- Procedures for adding new members, transferring ownership, membership buyout, and member withdrawal.
- Conditions under which the LLC can be dissolved and the process for settling debts or distributing assets.
It’s also recommended that you consult with an expert who can help you figure out how to customize the template for your company.
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