An LLC is a business structure that is often used due to its flexibility and asset protection possibilities. It is a legal entity separate from its members, which enables them to have a limited liability for the operation of the company. A limited liability means that the individual assets of the LLC members cannot be used to cover the debts and obligations of the LLC.
Besides that, many people choose to form an LLC due to its flexible management structure, the possibility of transferring financial interests in the company, and pass-through taxation.
What is an Operating Agreement?
An operating agreement is a legal document signed between the members of the company that are establishing the LLC for the purpose of defining the basic operational guidelines of the LLC.
It usually includes information about the LLC, such as its registered address and business activities, details about the members and their rights and obligations within the LLC, and the operating procedures that are going to be followed within the company. The main purpose of the LLC operating agreement is to set rules on how the company will be operated and what each member's interests are in the company. This will enable the proper functioning of the company and prevent potential disputes between its members.
Operating Agreement Forms By State
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Rhode Island
- South Carolina
- South Dakota
- West Virginia
Operating Agreement By Type
Single-member Operating Agreement
Multi-member Operating Agreement
Is an Operating Agreement Needed for an LLC?
In most states, an operating agreement is not needed for an LLC formation. However, states like California, Delaware, Maine, Missouri, and New York require submission of the operating agreement, among other documents needed for the formation of an LLC. This further means that you won’t be able to form an LLC in these states before drafting an operating agreement.
Regardless of the state requirements, many business owners choose to draft an LLC operating agreement before establishing their company. The main reason to draft the operating agreement before establishing an LLC is to outline the most important guidelines on how the company and the members within it will conduct business activities.
This is especially important for companies with more than one member since it serves as a tool for establishing the basic governing principles of the company, which potentially prevents disputes between the members over what their rights and duties within the company are.
What Information to Include in an Operating Agreement?
Information about the members
The operating agreement template should first include information about the members of the LLC. This includes their full names and mailing addresses. Apart from the basic information, the document usually includes information about the capital contribution of each member of the company as well as their ownership interest in the company.
Distribution of profit and loss
One of the crucial provisions for the members of the company is outlining the rules for how profits and losses will be distributed among the members. This is usually established proportionally to the capital contribution of each member. However, the members are free to make any kind of arrangement in this regard as they find it suitable.
Governing and management rules
Here, the members usually have two options. Either they can manage the company personally or hire a professional manager who will operate the company on a day-to-day basis. In either scenario, they should define the basic management rules, and if there are multiple managers of the company, define the authority and responsibility of each member.
The operating agreement template should also include the company’s accounting information, such as the frequency of audits for the company's accounts, books, and records maintenance, as well as the deadlines for when all the members should have access to the company’s financial reports.
In this section of the operating agreement, members can determine the rules for buying out the shares of the member who has withdrawn from the LLC. This is usually done by determining the order in which the remaining members can buy the shares, setting priorities among them, or setting priorities between members and third parties.
How to Write an Operating Agreement
To write an operating agreement, you should include a number of essential information and rules necessary for the operation of the company.
Below, you can see the step-by-step process of drafting the operating agreement:
Step #1. Identify the Members
Here, you should name all the members that are establishing the LLC. You can do so by entering their full names and mailing addresses. The order in which you will list the members of the LLC doesn’t have any significance in terms of their rights and obligations within the company.
Step #2. Add the Company Information
In this section, you should first provide the basic information about the company, such as the registered name, principal place of business, and office. Moreover, you should also provide the date of establishment of the LLC and a date of its termination if it’s known at the moment of establishment.
Step #3. List the Members’ Obligations and Voting Rights
The main obligation of the LLC members would be to make a capital contribution. However, the document can also include additional obligations for certain members of the company based on the agreement made between them.
Besides the obligations, the members can also determine their rights in the company. Most commonly, the operating agreement template will outline the member’s voting rights by determining how voting within the company can be done and how many members will constitute the quorum for voting.
Step #4. Elaborate on the Management Duties
In this section, you can name one or more members to manage the LLC or name one or more professional managers who are not members of the LLC to manage the company.
Regardless of which option you choose, you should define all the duties and responsibilities the company manager will have. This is especially important if there are multiple managers running the company since the operating agreement can determine the duties of each manager within the company.
Step #5. Outline the Capital Contributions
Here, you should provide detailed information on what each member will contribute to the company. These are usually certain monetary funds, but they can also be equipment, real estate, know-how, or other assets that can be significant for the formation or operation of the company.
Step #6. Account for Profits & Losses
This section will include detailed information on how the members will share the profits and losses of the company. This is usually established proportionally to the capital contributions of each member. However, members are free to determine profit and loss sharing at their own discretion.
Step #7. Define Salaries & Expenses
Here, you can determine who will receive salaries for their work in the company. The operating agreement template will usually provide that the members will not receive salaries. The fact that the members are receiving the company's profits mainly justifies this arrangement.
However, if certain members are also appointed as company managers, they might be eligible for compensation in that capacity. Besides the salaries, this section will also define how company expenses will be covered.
Step #8. Elaborate on Accounting Records & Taxes
In this section, you should outline the period in which the company accounts will be audited. This can be done annually, bi-annually, quarterly, or at any point the members decide by a majority of votes.
The agreement should also provide the date of the conclusion of the fiscal year as well as the date on which each member shall receive essential tax documents.
Step #9. Describe the Dissolution & End of Operation
The members should determine under which circumstances the company dissolution will take place. Besides the conditions provided by the state law or court order, the members can determine additional conditions for the company's dissolution.
This can include situations like bankruptcy, death, dissolution, expulsion, incapacity, or withdrawal of any member of the company. The members can also provide that the company may dissolve by a majority or unanimous vote of all the company members.
Step #10. Explain the Members’ Liability
In this section, you can provide more details on the liability of each company member. However, the level of liability should remain within the bounds set forth by the laws and regulations provided for the limited liability company.
Step #11. Add the Confidential Information
Here, you should provide guidelines for protecting the confidential information members and managers of the company will obtain. This section forms an obligation for each member or manager not to disclose confidential information to any third parties.
However, it also provides the exceptions under which they are allowed to share confidential information.
Step #12. Add Other Information
This usually includes provisions about severability, governing law, delivery of notices, and other supplemental information and disclaimers necessary for the execution of the agreement.
Benefits of Creating an Operating Agreement
Below, you can see the most important benefits of creating an operating agreement:
Advantages of Operating Agreement
Defining business operations and procedures. The main advantage of creating the operating agreement is that it will standardize how business will be conducted within the company. This will significantly increase efficiency within the company.
Customizing the default rules of the state law. The state law provides a general framework for the operation of companies within that state. The business owners can then use the operating agreement to provide specific rules within that framework according to their specific business model.
Providing business scalability. With the operating agreement in place, members will be in a better position to negotiate with new investors when expanding their business.
Providing additional liability protection. The operating agreement will further clarify the difference between the members' individual assets and the assets of the LLC.
Operating Agreement FAQ
An LLC agreement is the same as an operating agreement. It is a term for a document that defines the basic information about the LLC and its business operation. It can also be referred to as the LLC operating agreement or the operating agreement for a corporation.
California, Delaware, Maine, Missouri, and New York require an operating agreement to form an LLC. This means that you have to create the operating agreement and submit it, along with other documents needed for the company's establishment, to the company registration office.
Yes, even a single-member LLC needs an operating agreement. Even if there is only one member, the operating agreement provides provisions and safeguards that are crucial for the operation of the business.
Yes, you can make changes to an operating agreement. In a multi-member LLC, members can propose amendments to the operating agreement, and the amendments will be adopted if the majority or all of the LLC members vote for them.
Yes, the LLC operating agreements are enforceable documents. The operating agreement is basically a contract between the members of the LLC, and like any other contract, it can be enforced before the courts.
In most states, an LLC operating agreement doesn’t have to be filed or recorded with any official authority. In essence, an operating agreement is an internal document between the members of the company, and it can be kept in the company’s registered office. Moreover, every member of the company shall also have one copy of the operation agreement with them.
Whether you need a business plan after having already made an operating agreement depends on your specific business model. The operating agreement is a legal document that provides essential information about the company and its business operations, while the business plan serves as a roadmap for how the business will develop.