LLC Operating Agreement (A Complete Guide)
Many business owners start a limited liability company with the hope of limiting their risk. To do this, they need to have an LLC operating agreement.
You must understand what it does and what needs to be included before you decide to create one for your business.
This article will explain what an LLC operating agreement is and what it includes so that you can decide if you need one or if someone else should get them for you.
Quick Summary
- An LLC operating agreement is crucial for defining the structure and operations of a business, aiming to limit risks for owners.
- Essential components include details on ownership, voting rights, profit distribution, and procedures for disputes and debt management.
- Notably, LLCs with two or more members represent 71.5% of all partnership filings, highlighting the prevalence of multi-member LLCs.
- In my opinion, consulting a lawyer might be a safer route for comprehensive protection, despite the initial cost savings of DIY approaches.
What Is Included in LLC Operating Agreement?
An LLC operating agreement should comprehensively detail the structure and operations of the business.
So, whether your business entity is a single-member LLC or a multi-member LLC, there are some default rules an operating agreement should have.
The following are some of the things that an LLC operating agreement should include:
What Is the Purpose of an LLC Operating Agreement?
The purpose of an LLC operating agreement is to outline what the members will do regarding how they run their company.
It also outlines what happens if someone leaves and what would happen with debts or disputes among the owners of the LLC.
All members and managers should sign the agreement before it becomes a legal document to know what they agree to.
The LLC operating agreement will keep your business together if you lose one of the LLC members or go through any disputes among members of the company.
"An LLC operating agreement and a partnership agreement are both legal documents that outline the rules and regulations for how a business will operate. However, LLCs offer limited liability protection to their owners while partnerships do not."
-Thomas Howard, Business Lawyer & Consultant
It also outlines what would happen with your debts, who should take responsibility for them, and how to divide profits between owners.
How Do I Get an Operating Agreement?
You can create an LLC yourself or you can get one from a lawyer.
If you decide to draft the agreement yourself, be sure that what is included will keep everyone on board with how things are run or what happens if someone leaves.
A registered agent can also help you by drafting your agreement and then sending it to all members.
You can also use LLC operating agreement templates, which are available on the internet.
These templates typically have what is needed to run a successful limited liability company, but you will still want to adjust them for your specific needs and include what's relevant for your business.
1. LLC Name
The first section of an LLC agreement should include information about the LLC's organization.
It entails the exact legal name with the LLC designation, state of formation, a general business purpose clause, any DBA names, details of name reservation or registration, and the address of the principal place of business to ensure clear legal identity.
2. Ownership Details
The operating agreement should clearly delineate the ownership framework, illustrating the correlation between each member's capital investment in the LLC and their respective shares in ownership, profits, and losses.
Notably, LLCs with two or more members represent 71.5% of all partnership filings [1].
This section must include the names, addresses, job titles, responsibilities, and extent of ownership for every participant.
It's crucial for members to scrutinize this segment to confirm the precise distribution of assets and shares.
3. Voting Rights and Decision-Making Powers
The voting process is crucial for an LLC, and operating agreements must detail it, including secret or open ballot methods.
The agreement usually specifies two voting methods: one proportional to ownership, where a 40% shareholder has more influence than a 10% shareholder, and another granting one vote per member, regardless of ownership size [2]. It's essential to outline who has voting rights and the criteria for a quorum.
4. Profit Distributions
LLC operating agreements should contain provisions explaining how business assets and personal assets are distributed among LLC members.
The distribution provisions in an operating agreement can be either a default provision or they may require the unanimous consent of all the LLC members for any change.
In some cases, it will make sense to put restrictions on when distributions can occur if the business is still generating profits.
Still, you would like to delay the company from actually distributing any profits until it has been generating a profit for an extended period.
5. Management
Limited liability companies can be either manager-managed or member-managed. Depending on the type of management you opted for, your operating agreement will differ.
The operating agreement for a manager-managed LLC should contain information about the roles of each member, how they will be compensated and what their responsibilities are.
The operating agreement for a member-managed company should include similar information, but it doesn't need to explain specific managerial positions or members' duties.
6. Record-Keeping
This section is essential to mandate the documentation of key business decisions, including minutes of meetings and resolutions. This should be complemented with detailed financial records, tracking income, expenses, and bank transactions.
Ownership records are crucial, documenting each member's stake, capital contributions, and any changes in ownership. Additionally, maintaining a thorough repository of legal and tax documents, such as state filings, tax returns, and licenses, is necessary for compliance and reference.
The section should also specify a retention policy for these records, including the format and duration for which they are kept. It must outline who has the right to access these records, ensuring transparency and accountability within the LLC.
7. Member Change Process
This section of an LLC operating agreement specifies what happens in case of membership changes.
These provisions will describe what happens if new members join or initial members leave.
They may also specify what happens if you convert a business partnership to an LLC or merge one LLC business with another.
If new members join, this section of the agreement will specify how their capital contributions are treated and what percentage of a member's interest in the business they own.
If initial members leave or die, there may also be terms specifying what happens to any business assets distributed to them as part of the business partnership.
You should carefully review the provisions in this section because they can have significant financial consequences for the current members of the business entity.
8. Meeting Requirements
This section of an operating agreement should clearly outline the scheduling, notification, and conduct of meetings. It must specify the frequency of regular meetings (like annual or quarterly meetings) and conditions under which special meetings are called, including who has the authority to call them and advance notice requirements.
The agreement should define a quorum for decision-making, typically a majority of members, and explain the voting process and thresholds for different decisions. Provisions for virtual meetings, the responsibility for recording minutes, and the storage of these records are essential.
Furthermore, it should set clear expectations for member participation and address the consequences of non-attendance.
9. Operational Rules and Regulations
In this section of an LLC operating agreement, it's essential to specify the company's adherence to legal regulations, set business hours and office location, outline financial processes, explain methods for resolving conflicts, and lay down guidelines for amending the agreement, thereby promoting clear and effective management.
The agreement should also include what happens to the management structure if someone leaves or what has to happen for a member to leave.
This is called "dissolution of the LLC." Dissolution could be by a disability, bankruptcy or death of an LLC member.
It includes what will happen with remaining members and assets and what debts are leftover from the business, such as tax liabilities.
How to Write an LLC Operating Agreement - Choose Your State:
- Alabama
- Alaska
- Arizona
- Arkansas
- California
- Colorado
- Connecticut
- Delaware
- Florida
- Georgia
- Hawaii
- Idaho
- Illinois
- Indiana
- Iowa
- Kansas
- Kentucky
- Louisiana
- Maine
- Maryland
- Massachusetts
- Michigan
- Minnesota
- Mississippi
- Missouri
- Montana
- Nebraska
- Nevada
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- Rhode Island
- South Carolina
- South Dakota
- Tennessee
- Texas
- Utah
- Vermont
- Virginia
- Washington
- West Virginia
- Wisconsin
- Wyoming
FAQs
Can I Write My Own Operating Agreement for My LLC?
Yes, you can write your own LLC agreement if you're the business owner.
If there are multiple owners, it is best to have an attorney or law firm draft legal documents to ensure they adhere to LLC laws.
How Much Is a Limited Liability Company Operating Agreement?
The cost of LLC operating agreements varies. If you're making your own LLC operating agreement, the only cost you'll have to cover is the template you can purchase online.
The price of online templates can go as much as $200, but if you dig deeper, you'll be able to find some free LLC operating agreement templates.
Suppose you decide to hire a business lawyer to do this for you. In that case, the cost of this service will probably depend on the type of your LLC (single-member LLC and LLCs with multiple members usually need slightly different operating agreements).
How Does an LLC Operating Agreement Differ From the Articles of Organization?
The LLC's operating agreement is an internal document detailing the operating procedures and ownership details, while the Articles of Organization are a public record filed with the state, outlining the basic information of the LLC's business structure.
