What Is an LLC Operating Agreement (The Complete Guide)

The LLC operating agreement crucially influences the structure and functions of your limited liability company, be it a single-member LLC, multi-member LLC, or any other business entity type.

While it outlines the default rules governing member meetings and roles, it also serves as a safety net, limiting personal liability.

Within our experienced circle, we’ve witnessed how an LLC operating agreement transforms into the backbone of a firm’s business structure.

From detailing the responsibilities of LLC members to identifying the registered agent, it operates as the driving manual for your venture.

Remember, the absence of this agreement could make your LLC bend to LLC laws dictated by the state.

We are thus here to illuminate and simplify your path, helping you understand precisely what an LLC Operating Agreement is and how it can tailor your business toward success. Let’s begin!

Brief Overview

  • An LLC operating agreement solidifies ownership, management, and legal protections for your business.
  • The agreement, which can be drafted by owners, a legal professional, or using services like ZenBusiness, embeds crucial details such as business name and LLC membership.
  • Despite rules varying by state, having a comprehensive, signed agreement maintains credibility and clarifies taxation requirements.

What Is an LLC Operating Agreement?

An LLC operating agreement is a legal document that outlines the ownership structure, managerial duties, and operating procedures of a limited liability company, catering to both single-member and multi-member LLCs. It helps streamline business operations and limit personal liability.

How LLC Operating Agreements Work

LLC operating agreements, offering clearly defined roles and rights to members, function as game plans for these business entities. Essentially, they dictate how day-to-day operations take place and what happens if disagreements arise.

As in the logic of a football coach, strategies (roles and rights) are set in motion at the inception stage (creation of the LLC). If disputes surface (like in a game), the agreement offers mitigating strategies. For example, provisions for dispute resolution.

In essence, think of operating agreements as the detailed playbook—a comprehensive play with already established rules and directions—for the LLC’s successful operation.

What to Include in an LLC Operating Agreement

Over the years, we drafted hundreds of operating agreements, which helped us understand what is mandatory when creating an efficient legal document like this one. Let’s take a look.

1. Company Details

The first essential aspect to address in your LLC operating agreement is company details. As a legal contract, this document must clearly state basic information about your business entity, like the business’s industry, registered agent, and office address.

This segment serves as the LLC’s identity and therefore needs to be precise and accurate.

2. Tax Treatment Preference

The IRS does not recognize an LLC as a classification for federal tax purposes. LLC members have the freedom to determine whether the IRS should treat their LLC as a sole proprietorship, partnership, or corporation for tax purposes.

Your operating agreement must contain the chosen tax classification to avoid complexities with the IRS.

3. Member Information

This information in the operating agreement is the core foundation of the LLC status, providing a blueprint for the company’s internal affairs.

It comprises basic information, like names and addresses of the members, ownership interest (expressed in percentages), member contributions towards capital accounts like cash, property, or intellectual property, and their voting rights.

More than one member means a decision-making process, usually based on a unanimous vote or majority rule.

If there’s only one member, the LLC is classified as a ‘disregarded entity’ but still requires an operating agreement to maintain limited liability status, protecting personal assets from business liabilities.

4. Management and Voting

Typically, an LLC can be member-managed, where members handle day-to-day duties, or manager-managed, where one or more managers (who may or may not be members) are appointed.

Details about whoever is in charge of managing the LLC, how they are appointed, their duration of service, responsibilities, decision-making power, and process for removal should be outlined.

It’s also crucial to discuss voting rights: along what lines are they distributed (membership interest or equal sharing), what decisions require member votes, and the voting process itself.

5. Capital Contributions

This section refers to the financial input that members offer to launch or maintain a limited liability company (LLC).

In our hands-on exploration, we’ve found this to be a crucial component of an LLC operating agreement that establishes a member’s ownership stake, often following their initial investment.

Such definitions include specifics like each member’s contributions, whether in the form of money, property, or services.

6. Distribution of Profits and Losses

Next, defining how the LLC’s profits and losses are distributed among members is of utmost importance.

In our experience with many LLC operating agreements, we’ve noticed that neglecting to define distribution rules can lead to disputes and complications in a company’s status.

In simple terms, the LLC operating agreement should outline the percentage of profits and losses each member will receive, typically reflecting their capital contributions.

7. Membership Changes

In your LLC operating agreement, having a section on membership changes is vital. These considerations typically outline the rules for adding new LLC members and what happens when a member wants to leave, or if a member’s death or incapacity occurs. It also elucidates how to manage changes to ownership percentages.

For example, in the case of single-member LLCs that become multi-member LLCs, this documentation ensures that clear, legally binding procedures are in place.

The inclusion of such protocols within your operating agreement can have a significant impact on the fluid management of your LLC.

8. Dissolution Procedures

The dissolution clause explicates the necessary steps to wind down the business. After a thorough examination, we determined specifics such as selling business assets, paying off debts, and distributing remaining assets to members should be included.

This wind-down procedure should be followed in the event of a voluntary LLC dissolution, a set end date in the agreement, a member’s death, or other events listed in your rules.

9. Indemnification and Liability Clauses

Indemnification clauses protect the LLC owners and managers from personal responsibility if the business is held accountable for financial or other damages.

Liability clauses define the degree of personal responsibility borne by the members for the company’s debts, losses, or litigation.

The LLC agreement underlines the limited liability protection offered by a corporation but with a more flexible approach – just like in a partnership.

10. Dispute Resolution

This research paper showed that operating agreements function as binding contracts, and having a binding contract defining how disagreements are resolved can help the business operate smoothly, especially when the unexpected happens.

It reduces the chance of legal battles and shattering potential gridlocks.

By doing so, members ensure they have a given right to arbitrate disputes rather than taking them directly to court, offering potentially significant savings both in time and money.

Six Ways an Operating Agreement Benefits Your Business

With years of experience in the field, we’ve found that an operating agreement puts into writing what often starts as verbal discussions between parties setting up an LLC. And that’s just one of many benefits we’ve seen.

Clarifies Verbal Agreements

Consider this: You and your partner, with your budding new business venture, decide how you will distribute profits. Without a written agreement, these discussions remain verbal and can lead to future misunderstandings.

An operating agreement requires members to deliberate on important matters, put them into writing, and sign the document, cementing the terms of the partnership.

Protection from Legal Disputes

Protection from legal disputes becomes more robust with an operating agreement in place. For example, the responsibility split between members is detailed in these statements.

If any member acts on behalf of the company without the consent of others, personal liability can be invoked.

This written document serves as a legally required contract, protecting the business and individual members from legal disputes that may arise from misrepresented actions or foreign transactions.

Flexibility in Management

Each business has unique needs. Some opt for a manager-managed LLC, allowing selected members or persons outside the LLC to control business affairs. Alternatively, others elect all members to manage business affairs, creating a partner-like relationship.

This management structure is typically solidified in the operating agreement, allowing flexibility and future modifications to accommodate business growth.

Prevent State’s Default Rules

Without an operating agreement, an LLC would be governed by the state’s default rules. This, in most cases, limits the flexibility of your business. An operating agreement allows you to run your business according to your specific needs.

For example, in a state like California, if you’re the sole member of the LLC and don’t draft an LLC operating agreement, the state imposes its own guidelines, which can sometimes overlook your business purpose.

Improved Credibility

This study has shown that when it comes to attracting investors and partners, credibility is crucial. An LLC operating agreement serves as an official contract that members sign, boosting the business’s legitimacy.

It helps in separating personal from business finances, preserving the member’s rights, and maintaining the corporate veil.

So, whether your business is in Missouri, where state laws require operating agreements, or New York, your business’s legal background is solidified by this document.

Facilitates Decision-Making Process

An operating agreement clarifies the roles and responsibilities of members, making decision-making efficient. It specifies manager actions, income tax instructions, conflict resolution measures, or even wind-down procedures.

It doesn’t just guide new ventures but also how changes, like when members agree to sell their interests, are dealt with.

A detail-oriented lawyer, with knowledge about the state’s requirements and potential scenarios your business may face, could assist in drafting this essential document.

Which States Require LLC Operating Agreements?

While most states don’t legally require LLCs to have an operating agreement, it’s highly recommended. Only five states legally mandate this:

  • California: According to the California Corporations Code, all LLCs that have more than one member are required to have a written operating agreement.
  • Delaware: Delaware requires all LLCs to have an operating agreement, but it doesn’t have to be in writing.
  • New York: As per the New York LLC Law, all LLCs must have a written operating agreement within 90 days of forming the business.
  • Missouri: Requires an operating agreement that needs to be signed by all members.
  • Maine: All companies must draft an operating agreement before they can be formed.

How Much Does an Operating Agreement Cost?

The cost of an LLC Operating Agreement can vary widely based on your specific needs and the professional help you seek. If you decide to draft it yourself using online resources, it could be virtually free.

However, using an online legal service might cost you between $50 to $200.

If you choose to hire a lawyer to help draft a custom agreement tailored to your business, it could cost you anywhere from $1,000 to $5,000 or more, depending on the lawyer’s fees and the complexity of your business.

What Is the Simplest Way to Create an LLC Operating Agreement?

With some time and research, you as the owner can draft the agreement, encompassing vital elements like business name, LLC membership, liability statement, capital accounts, and other provisions.

However, tax considerations, unfamiliar verbiage, or complex stipulations may suggest consulting an attorney.

Alternatively, a middle ground does exist—business formation services like ZenBusiness. They provide templates for consideration of personal tax return implications and filing fees, speeding up the process without overlooking important parts.

Regardless of the path chosen, ensuring the agreement is signed is crucial. The LLC operating agreement, while not the same as a business plan, is a cornerstone of your LLC’s foundation and helps establish credibility with banks and potential creditors.

FAQs

Does a Single-Member LLC Need an Operating Agreement?

Yes, a single-member LLC does need an operating agreement. It helps secure liability protection, outlines the company’s management structure, and creates credibility with lenders, even with a single-member entity.

Can You Modify an LLC Operating Agreement?

Yes, an LLC operating agreement can be modified. Changes, known as amendments, require agreement from members according to voting rules set out in the original operating agreement.

Do I Need to Submit My LLC Operating Agreement to the State?

In most states, you do not need to submit your LLC operating agreement to the state. However, you should keep it with your important business records for reference and legal protection.

Does an LLC Operating Agreement Require Notarization?

Typically, an LLC operating agreement does not require notarization. Nonetheless, some businesses choose to notarize it for an added layer of security, certifying the authenticity of the signatures therein. Always check local and state regulations for specific requirements.

Do LLC Operating Agreements Have Legal Enforceability?

Yes, LLC operating agreements are legally binding. They govern the internal operations of the LLC and set the rules and procedures for issues such as decision-making and dispute resolution. Breach of these agreements can lead to legal consequences.

How Does an LLC Operating Agreement Differ From Articles of Organization?

The articles of organization officially register the LLC with the state and provide basic company details while the operating agreement outlines the internal governance, rules, and procedures of the business.

References:

  1. https://heinonline.org/HOL/LandingPage?handle=hein.journals/smulr68&div=44&id=&page=
  2. https://www.tandfonline.com/doi/abs/10.1080/09638180701265903
  3. https://www.irs.gov/
Carla Baker

Carla Baker

With an MBA from the University of Pennsylvania and a proven track record, our Co-Founder brings expert guidance to new small businesses and LLCs. Her portfolio showcases a history of successfully launching and managing diverse ventures, while her passion lies in empowering others to navigate the world of business.