What Is an LLC Operating Agreement?
Your LLC’s operating agreement is an internal document designed to outline the duties of each member or manager in the business and provide guidelines as to how your business operates. While not all states require this document, it is highly advisable to create one as they provide protection for your LLC’s status, plus other benefits.
If you are new to the idea of creating an operating agreement for your business and aren’t too sure where to start, don’t worry. Our article will give you the rundown on what an operating agreement is and its purpose. We’ll also give details on the benefits of creating an operating agreement and pointers about what to include in yours.
The Basics of an LLC Operating Agreement
As mentioned above, an operating agreement is an internal document created for your LLC. It sets clear guidelines on how your business is run, what to do in the case of a lawsuit or other business conflict, and the rights of your LLC’s members and managers. The rules and guidelines set forth in your operating agreement helps to establish your LLC as a separately operating business entity and will take precedence over state LLC law when it comes to certain governing aspects.
If you choose not to create an operating agreement for your LLC, your business is liable to governance by state LLC law in the event of conflicts or other business issues, which may not necessarily be in your favor.
It is also important to note that many business bank accounts and loans can only be applied for when you have your business’s operating agreement on hand, in addition to other internal documents like your Articles of Organization and your business’s EIN (when applicable). Creating an operating agreement can help vouch for your business when applying for anything finance-wise.
Is Your LLC Required to Have an Operating Agreement?
Some states require that your LLC has an operating agreement; these include California, New York, Missouri, Maine, and Delaware. That said, any LLC can benefit from having an operating agreement on hand.
Additionally, when establishing your LLC, you should carefully check the rules and requirements on operating agreements to ensure that you have all internal documents to meet state-specific rules and regulations.
The Benefits of Drafting an LLC Operating Agreement
Drafting up an LLC operating agreement for your business can have many benefits, the most important of which we discuss below.
Protect and Define Your LLC Status
Documenting your LLC’s operating rules and processes is a highly important step in defining your LLC as a separately functioning business. This is especially useful for single-member LLCs that may need to demonstrate that their LLC is a separate entity from their own personal assets.
An operating agreement may also improve your business’s corporate veil, making it more likely for customers to trust your LLC as a reputable, independently operating business.
Prevent Conflicts Among Members
Another major benefit of having a clear operating agreement drafted up when your business is established is conflict prevention. Because the rules and regulations of your LLC’s operations have already been agreed upon and written down, there is less risk of disagreements arising between members about the direction or operations of your LLC. Having established rules can also put a stop to any arguments by giving a member or manager the final say over a particular topic.
Customize Your LLC’s Rules
If your LLC does not have an operating agreement, the state that your LLC is established in will take precedence over your LLC’s operations. In most cases, this is not in your business’s favor and could put you at risk of future conflicts based on your state’s particular LLC law. Once your operating agreement is created, it is the first thing that is consulted in the case of any decision, lawsuit, or conflict, allowing you to customize actions and resolutions to your business’s benefit.
Establish Profit Division
A very important part of running a business is establishing the profit divisions among members or managers. Certain tax treatments may require you to pay yourself set amounts of income each year, or you may want to customize your LLC’s profit division based on the rights of each member or manager.
Drafting up your operating agreement ahead of time can greatly clarify this process and give all members or managers of the LLC something to refer back to when discussing profits.
Set Guidelines for Your LLC’s Future
Depending on what you want for your business, you may want to set rules for what happens if a founding member or manager of your LLC passes away, your business encounters debts, or your LLC is met with a lawsuit. This can be included in your operating agreement. You may also want to specify what is to happen in the event of business dissolution in the state or if operations come to a natural stopping point.
What Should You Include in Your Operating Agreement?
If you are new to the LLC establishment process, you may be wondering what goes into an operating agreement. Below, we give you a basic guideline of what you should include in your agreement.
Basic LLC Information
When establishing an operating agreement, it is important to include your LLC’s basic information. In general, this will be any information about your business that you filed with the state as part of your operating agreement. We give you a preview of what could potentially be included below.
- Your LLC’s legal name
- Any trade or DBA name that your LLC uses
- Your LLC’s principal office address
- Your LLC’s registered agent’s name and address
- Your LLC’s duration, if not perpetual. Make sure to include a specific project or time frame for your LLC’s operations if applicable.
Tax Information
It is important to indicate how your LLC will be taxed as part of your operating agreement. Most states treat LLCs as pass-through entities by default, but you may want to file separate paperwork with the IRS to have your LLC taxed as either an S Corporation or a C Corporation.
Be sure to include your LLC’s tax information and any specifics on filing taxes that you feel are necessary to clarify.
Your LLC’s Purpose
In addition to your LLC’s basic information, you should include information about your LLC’s industry and the major service or product that you are offering. You may also want to include wording about permitting your LLC to engage in “any lawful purpose,” as this gives your business the freedom to switch to a different business industry or product later on.
Statement of intent
Along with your LLC’s purpose, you should include a statement in your operating agreement that states your LLC agrees to conform to the LLC laws of the state you are operating out of. It should also clarify that after all necessary and required documents have been filed, the LLC will officially come into existence.
Your LLC’s Member and Manager Information
Another important factor to include in your operating agreement is information about each member or manager. This is also the point in which you should specify whether your LLC is going to be member-managed or manager-managed. Once you have decided on a management structure, you need to detail the responsibility of the managers or members, including information like salary and employment duration. Make sure to also include the procedures for electing or firing members or managers.
As you appoint members or managers, include the following information in your operating agreement.
- The individual’s name, address, and title
- The individual’s job responsibilities
- The individual’s ownership percentages, salary, and potential employment duration
Member Contributions
Along with basic information about your members or managers, you will need your operating agreement to outline what each individual has contributed to your business and the estimated value of each contribution. This may include contributions of property, labor, intellectual property, or money.
For those that have contributed to your LLC, you may provide an ownership percentage or interest in your business. This means the individual has capital in your LLC, and you need to specify whether this percentage is equal to the amount that the individual contributed in the first place.
It is essential to keep track of individual contributions and member percentages, as this will be helpful when figuring out payment structures and voting or approval rights.
Member or Manager Compensations
How much each member or manager is compensated depends on their specific role in the business and how your LLC is taxed. LLCs that opt to be taxed as a corporation by the IRS will need to receive a salary, but LLCs that elect to be taxed as a pass-through entity (which is generally the default) will likely receive profit distributions based on how much percentage or ownership interest they have in the LLC.
It is important to decide on these elements ahead of time and clearly outline them in your operating agreement to avoid conflicts or confusion in the future.
Member Meetings
Your LLC will not be required to hold regular meetings like a corporation, but many LLC owners choose to schedule routine meetings into their operating agreements anyway. This helps members or managers get together and vote on important topics.
Make sure your operating agreement gives a basic summary of the time, place, and manner (for example, in person or video call) of any meeting that may be held, in addition to the general purpose of each meeting.
Voting and Approval Rights
When you are listing any type of meeting requirements for your LLC, you should also take time to note down voting and approval rights. During meetings, members or managers will have the opportunity to vote on important decisions and potential changes to how your business is run.
Any section in your operating agreement that discusses voting or approval rights should clearly outline the voting share that each member or manager receives and whether a simple majority will be the utilized voting system. You may also want to add a line or two that gives you the freedom to change the voting procedures at a future date and the process for doing so.
New Members and Exit Rights
In general, you must include a section in your operating agreement about the process for admitting new members or managers. Most LLCs choose to use a process that requires a meeting of all the current members and a vote.
At the same time, you should be including directives for what to do when a member or manager wants to leave the business and how their ownership interest is handled. You may even want to put down rules or requirements on what the exiting individual can and cannot do with their ownership interest.
Dissolution
Another essential section in your operating agreement is addresses what to do if your members or managers want to dissolve the business, or the business has come to a natural conclusion and needs to be formally dissolved. In most cases, a vote is taken to agree on the dissolution proceedings for your business.
Make sure that you also outline the wind-down process for your LLC including filling dissolution notices with the state, paying off debts, liquidating assets, and any other applicable task for your business.
Additional Provisions
While many operating agreements include several of the same notions in terms of member voting rights, payment structures, and basic information, there are several factors that are business- and product-dependent. You may want to add additional provisions based on your business type or on your specific needs for your operating agreement. Below, we have examples of what else you may want to include in your operating agreement.
- Liability Statements – This specifies that LLC members and managers have limited liability protection.
- Death of a Member – This states what should happen if a member or manager of your LLC unexpectedly passes away.
- Dispute Resolution – This should include the full process for dealing with a conflict and the steps taken for resolution.
- Communication – This concerns how important notices are passed among LLC members (for example, via email or phone).
- State Law – This statement exists to identify and define state laws that your LLC follows. This provision simply identifies the state law that governs the LLC.
- Special Agreements – This refers to any special agreement your LLC may have in place, including non-compete agreements or conflict of interest policies.
Be sure when drafting your operating agreement that you take stock of what is important to include and what you want outlined for your LLC. An operating agreement template can help you get started, but you should always strive to tailor the agreement to be specific to your business, as this gives you the most benefits.
LLC Operating Agreement FAQs
The answers to these frequently asked questions about LLC operating agreements can help you further understand the benefits behind this important business document.
Can You Use an Operating Agreement Template?
When you first draft your LLC’s operating agreement, it is perfectly acceptable to use a template to help you get started. However, you should change the template to match any state-specific LLC regulations and to match your expectations of how your business should be run. Take your time and go through the template and change anything that doesn’t agree with how you want your LLC run.
Does Your Operating Agreement Need to Be Notarized?
No, your operating agreement does not need to be notarized, even in states that require you to draft an operating agreement. However, in those states where this document is required, you likely need to file your agreement with the state at the same time as you file your Articles of Organization. Be sure to check with state-specific rules when it comes time to create and file your document.
Do You Need an Operating Agreement for Single-Member LLCs?
While you don’t need to draft up an operating agreement for your single-member LLC unless your state requires it, it is a good idea to create one anyway. Single-member LLCs can benefit from the corporate veil and proof of separate business entity that an operating agreement brings. Creating this document as a single-member LLC may make it easier to secure business financing and build trust with your customer base.
Who Signs Your Operating Agreement?
After you have created your operating agreement, you need to add signature pages at the back of it. Every member or manager whose information is listed in the operating agreement must sign the document. Each signature should be on a separate page for clarity purposes.
Can an LLC Operating Agreement Be Changed?
Yes, you can change your LLC’s operating agreement once drafted. As you are creating your operating agreement for the first time, you may want to put in a section that outlines the procedures for any changes and how your LLC’s members or managers decide on the changes. Most business owners choose to use a voting system for this process.
After your LLC’s members or managers have agreed on changes, you can draft up the new agreement and have every individual named in the document sign once again, completing the change process.
What if an LLC Has No Operating Agreement?
If you choose not to create an operating agreement for your LLC, you may be at risk of several determinantal things. First of all, if you don’t create an operating agreement in a state that requires this document, you risk being involuntarily dissolved or not being allowed to operate in that specific state.
For states that don’t require operating agreements and you choose not to draft one, your business must adhere to state LLC law in the case of conflicts, lawsuits, or other governing decisions. State LLC law may not be in the best interest of your business or your assets, which is why creating an operating agreement is highly recommended no matter what.
Clearly Governing Your LLC
An LLC operating agreement is an important internal document that every business can benefit from. Your operating agreement sets aside guidelines for your business and ensures that conflicts are resolved easily. It also ensures that your business is governed according to your best interests in the case of issues such as conflicts or lawsuits.
Now that you understand exactly what an LLC operating agreement is, you can use the pointers in our article to draft up your own document and start governing your LLC.