An LLC operating agreement can serve as a directive for a limited liability company and outline the responsibilities of the owners (called members). Although it’s not legally required by every state, it is prudent to keep an operating agreement, even for single-member LLCs.
What is an LLC operating agreement?
An operating agreement is a legal document, essentially a contract, that outlines the internal structure of an LLC and provides details about how the business will be managed, the rights and responsibilities of each member, how members will be paid and procedures in case of dispute among members or dissolution of the company. Once an agreement is drawn up, it’s signed by each member of the LLC.
An operating agreement is specific to an LLC — with companies structured as C corps or S corps, this document is referred to as corporate bylaws.
» MORE: LLCs vs. corporations
Is an LLC operating agreement required?
Only a few states — California, Maine, Missouri and New York — require LLCs to have an operating agreement before selling any products or services. In these states, even single-member LLCs must have an operating agreement.
Even though an operating agreement isn’t required by most states, it can provide guidance for the future of the business and protect owners from being held personally liable for a business. It also details the organization of your company for lenders or potential investors, many of whom will request an operating agreement before giving capital to your business.
How to create an LLC operating agreement
Unless you have a legal background, you may want to outsource creating an operating agreement. For simpler situations, you can use a template or an online legal service, like LegalZoom or Rocket Lawyer.
For more complicated situations, and especially if there are more than two members, you may consider enlisting the help of a business lawyer. Many lawyers will help you file articles of organization and write up your operating agreement for a flat fee.
Generally, the steps to create an LLC operating agreement are as follows.
1. Establish ownership and profit distribution
The LLC operating agreement should show what each owner has contributed to the business and the value of each contribution, whether it’s capital, property, skills, labor, intellectual property or other resources.
Member compensation depends on each member’s role within the business and how the LLC elects to pay taxes. If the LLC is taxed as a corporation, members can receive a salary for their work in the business, along with distributions. If the LLC is taxed as a disregarded entity, members will only receive distributions based on their ownership interest in the company.
2. Determine the management structure
LLCs can be either member-managed or manager-managed. In member-managed LLCs, members run the daily operations of the business. In manager-managed, outside managers are brought in. If it is manager-managed, the agreement should detail a manager’s responsibilities, salary and tenure of employment. The method for terminating employment of a manager and electing a new one should also be provided.
3. Dictate the rights and responsibilities of members
The voting provisions should clearly outline the voting share of each member — usually equal to their ownership interest. It should also specify whether a simple majority is sufficient to finalize a vote.
4. Outline the procedures for dissolution
The LLC operating agreement should also address the process for dissolving the business, usually triggered by a member vote, including filing appropriate forms with the state, liquidating assets, paying creditors and more.
What to include in an operating agreement
The basic information that’s included in your articles of organization filed with the state will also be included in your LLC operating agreement, including the company name plus any fictitious business names or DBAs, the company address, and the name and address of the registered agent.
Your LLC operating agreement should also contain information about each member and manager, including their name, address, title, job responsibilities and ownership percentage.
Here’s a breakdown of what to include in your LLC operating agreement:
- Business purpose. A line or two about the business’s industry and primary product or service. This may also include a line that permits the business to engage in any lawful purpose, giving the business freedom to pivot later.
- Statement of intent. This statement specifies that the operating agreement conforms to the LLC laws of your state and that after all of the proper documents have been filed, the business will come into existence.
- Duration of the business. Unless your LLC is set up for a specific project or time frame, like a joint venture, for example, this section would include a brief statement that allows the LLC to continue in perpetuity.
- Tax treatment. By default, LLCs are taxed as partnerships or disregarded entities (single-member LLCs). However, LLCs can elect to be taxed as S corps or C corps by filing forms with the IRS. You should indicate your LLC’s preferred tax treatment in the LLC operating agreement.
- Member meetings. The agreement should summarize the time, place and manner of the meetings, as well as the purpose of each meeting.
- New members and exit rights. The LLC operating agreement should outline the process for the entry and exit of members. Most operating agreements grant a right of first refusal to existing owners to purchase outgoing owners’ interests so that members retain close control over the business.
Additional provisions for LLC operating agreements
There are a handful of other provisions you might include in an agreement:
- Liability statement: This language specifies that the LLC members have limited liability protection as members.
- Death of a member: This provision would detail the procedure that takes place in the event that a member passes away.
- Dispute resolution: What happens if there’s a dispute amongst members? This provision would outline the process to follow.
Benefits of having an LLC operating agreement
Even if it’s not required in your state, an operating agreement provides a lot of key benefits for your business.
Protection from personal liability
An LLC protects you from personal liability — meaning your personal credit and assets are safe if anything with the business goes awry. An LLC operating agreement solidifies the legal separation between the members and the business operations, reinforcing this protection. This separation is particularly important for single-member LLCs.
» MORE: LLC vs. sole proprietorship
Control over governing rules
In the absence of an LLC operating agreement, the state’s default rules kick in, which means your LLC will be subject to how the state approaches management, admission of new members, dissolution, profit distribution and more. Creating your own LLC operating agreement overrides these rules.
Provides clarity for owners and investors
An LLC operating agreement contains clear provisions about each owner’s contributions to the business, share of profits, and responsibilities to the company and other members. It can serve as a reference to resolve any potential conflicts and provide clarity about the direction of the business for the members themselves and potential investors or lenders.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.
