In other words: your new business (and all its actions + obligations) will be legally separated from you as a person. That’s a big boon.
But to benefit from LLC protections, you need to prepare and complete a lot of legal documents.
An operating agreement is one of them.
Wait, what is an LLC operating agreement? Why do I need one?
Let’s unpack this.
Table of contents
- What is an LLC operating agreement?
- What should be included in an LLC operating agreement?
- How do I get an operating agreement?
- FAQs about operating agreements
What is an LLC operating agreement?
An LLC operating agreement (or LLC agreement for short) is a legal document that establishes the rules, regulations, and provisions for structuring and running your business.
The operating agreement controls the relationship among LLC owners.
It covers matters such as:
- Decision-making powers
- Member capital contributions
- Ownership interest percentage
- Distribution of profits and losses
- Members’ voting rights
- Dispute resolution process
- LLC dissolution procedures
LLC members sign operating agreements to declare that they will abide by the agreement’s terms.
Is an LLC required to have an operating agreement?
Legally, only 4 states – California, Delaware, Maine, Missouri, and New York – require LLCs to have a written operating agreement. It doesn’t have to be filed with the state authorities but stored internally. Other states leave this to your judgment. You can have an oral or implied agreement (e.g., members of an LLC accept to be governed by the default LLC state laws).
But without a written and signed operating agreement, you’ll have to adhere to state statutes, which may be vague, subject to change, and not in favor of your issue.
Unlike your Articles of Organization, which you must file with the Secretary of State when forming your LLC, you don’t need to submit an operating agreement with any state governing body.
We recommend checking the requirements with your state’s business registration division so you can stay compliant.
Overall, business owners should create a written LLC operating agreement when:
- The LLC has two or more members: The operating agreement details how decisions will be made in case of disputes, plus lists the rights and obligations of each member.
- You’re a single-member LLC seeking funding: Without an operating agreement, it may be harder to articulate your stake/role in the business to potential investors or creditors.
What should be included in an LLC operating agreement?
An operating agreement is tailored to your type of business and industry. So no two documents are entirely alike.
But, there are several standard points your operating agreement must cover:
- Company details
- Member information
- Accounting practices
- Operational procedures
- Additional provisions, e.g., amendments and governing law
An operating agreement has to open with a general snapshot of your company.
Basic company details
Describe your company’s essential characteristics in your operating agreement:
- Legal name
- Doing Business As (DBA) or fictitious names
- Company address
- Registered agent’s name and address
You can also add a line or two about your business’s purpose, industry, and nature (e.g., primary product or service and any other lawful business purpose).
Statement of intent
This section states that the operating agreement should comply with the state LLC laws. It also specifies that your business comes into existence once the owner files all proper legal documents with the state.
Your LLC operating agreement needs to list each member and manager’s name, address, title, job responsibilities, and ownership percentages proportionate to their capital contributions.
Specify whether the LLC is a member-managed or manager-managed company. If manager-managed, include the manager’s responsibilities, salary, and employment tenure.
This section defines whether the LLC will be taxed as a sole proprietorship, partnership, or corporation (S-corp or C-corp).
You can learn more about how LLCs file taxes from our previous post.
Along with the general information about each member and manager, the operating agreement also has to detail:
- Member rights, obligations, and duties: List each member’s rights related to the business, their duties, and responsibilities.
- Member contributions and ownership allocations: Specify the stake of each owner, proportional to their capital. Members can contribute cash or in-kind (e.g., skills, property, labor, intellectual property, or other resources).
- Voting and approval rights: Outline procedures (e.g., time, place, and manner) for making decisions through periodic meetings, the purpose of each session, and each member’s voting rights.
- Compensation: Specify how individual members will be compensated depending on their roles and how your LLC is taxed.
Your LLC operating agreement should also define:
- Fiscal year: Specify the fiscal year your business will use. Most LLCs use a calendar year.
- Accounting method: The two common types are cash-basis and accrual accounting. The former is easier to do but only allowed for businesses with $5 million or less in gross annual receipt.
- Profit distribution: Provide general guidelines for profit distribution. This can be merit- or contribution-based. Or backed by a formula.
Other common types of provisions you should cover in your operating agreement include rules for LLC dissolution, voting rights, and procedures for adding new LLC members.
At some point, you may decide to close your LLC. Your operating agreement should address such a possibility and its implications for other members of the LLC:
- A plan for the end of your LLC, so you’re not forced to adhere to the state’s default rules when ending your business
- The vote needed to trigger dissolution proceedings
- How members split the LLC’s assets and losses prior to closure
- The wind-down procedures
At the same time, you may want to add a new member to your LLC or fire someone. Again, your operating agreement must put down the provisions for that.
- What happens if a member joins: Define the onboarding process, incentives they’ll get, and the required initial contribution.
- What happens when a member withdraws: Detail what the member is entitled to when they leave the LLC. You must also notify the Secretary of State when you have a change in ownership.
Meeting and voting procedures
Procedures like adding/removing members, closing an LLC, or selling it off require a member vote. As do many other operating decisions. Therefore, your operating agreement must explain how members cast votes.
- Meeting schedules: Summarize the place, time, and manner of meetings (e.g., video call or in-person).
- Voting rights: An LLC member can vote their membership percentages or get one vote no matter the size of their ownership shares.
- Voting procedures: Unlike corporations, which hold annual meetings for their shareholders and directors, LLCs can schedule periodic meetings at any time.
There are a handful of other provisions you can add to your LLC operating agreement, such as:
- Dispute resolution process. Outline the next step if there’s a tie in voting or some confrontations between members.
- Provisions in case of a member’s death. Detail what will happen to the member’s interest in the company in such a case.
- Any special arrangements. You may include conflict of interest policies, non-compete clauses, or other custom rules for operation.
How do I get an operating agreement?
You have three options to get an operating agreement:
- Draft an agreement yourself: There are many free and paid operating agreement templates online. For example, if you’re forming an LLC in Nevada, you can use their free online tool for creating operating agreements.
- Use a premium tool or service. Rocket Lawyer has a premium online template builder, while LegalZoom offers fast custom operating agreement creation for $99-$199.
- Pay a corporate attorney. You can hire a law firm to draft your operating agreement for you. This option can be pricey – about $350-$1,000 for single-member LLCs and $750-$5,000 for multi-member LLCs.
- An LLC operating agreement outlines the organizational and administration principles of your business entity.
- California, Delaware, Maine, Missouri, and New York legally require LLCs to have an operating agreement.
- You don’t need to file an operating agreement with any government or authority, even in states that require an agreement.
- You can use a free or premium tool/service or hire a corporate attorney to create your operating agreement.
FAQs about operating agreements
Here are answers to several frequently asked questions about LLC operating agreements.