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You’re probably wondering what an LLC operating agreement is and why you need one.
Simply put, an operating agreement is a document that contains the rules for running your LLC.
It might include how to share profits and losses among members. An operating agreement can also cover other aspects of running a business, such as member buyouts or death of a member, the management structure of the company, voting rights among members, and more.
Don’t worry if you feel confused about how these LLC agreements work. In this article, you’ll learn everything you need to know about setting one up for your LLC.
What is an LLC Operating Agreement?
An operating agreement is a contract between the LLC members that outlines how they will manage their business. It defines how the members will work with one another.
An operating agreement should include each member’s percentage of ownership, voting rights, and other responsibilities that all parties involved must remain upheld.
Why is an Operating Agreement Important?
The purpose of writing up an operating agreement for your LLC is to ensure that the company gets managed responsibly and that all members are on board with how to run it.
A big part of this management structure includes defining what happens in case something unexpected happens. For example, it helps to eliminate confusion if a member of the LLC passes away.
It also helps establish how to divide profits or what should happen if someone wants to sell their share in the company. The operating agreement protects everyone involved by providing clear guidelines on decisions that might arise in the future.
What Should an Operating Agreement Include?
Since most states don’t require your LLC to create an operating agreement, you have some leeway with what you choose to include in it. Here are some of the most important items to consider, including when drafting one.
The operating agreement should include essential information, such as the name of your LLC. Keep in mind that some states require you to use the term “Limited Liability Company” spelled out in its entirety when listing the company name. Other states want you to include the “LLC” abbreviation.
You should also include the LLC address and registered agent in the document. A registered agent serves the purpose of maintaining a physical address where people can mail official documents to the company. You don’t ever want your LLC to miss paperwork involving tax entities or lawsuits against the company.
You can also list details about the Articles of Organization in this section and the purpose behind forming the company.
Name of Members, Their Contributions, and Interest
The next part of your operating agreement should include information about every member. Include the name of each member, the percentage they own in the company, and how much money or assets they contributed to starting the business.
List out the company’s process for adding new members and when the company requires contributions by members. Other items to put in this section include distributing annual member profits and losses and how to distribute taxes each year.
LLC Management Rules
Generally speaking, you’ll hire a manager to manage the business, or you’ll make the LLC a member-managed company. If you hire a manager, list out their role and what type of authority the agreement provides them. You can also include what happens if there is no outside manager or whether members will take turns running the company as part of their duties.
It would be best if you talked about how to make decisions in this part of the agreement. For instance, you might want other members to provide their stamp of approval on some decisions even though you have a manager in place.
Procedures for Voting
In your LLC operating agreement, you’ll want to describe who gets one or more votes and when voting should happen.
Remain specific when laying out the voting procedures, so it’s obvious what it takes to pass a motion. For example, you might require LLC members to vote on significant decisions where they’ll need a majority of votes for the motion to pass. Suppose you allow for any ambiguity in this area. In that case, you’re inviting arguments in the future when some members don’t get their way.
In most cases, you’ll give each member one vote when making decisions. However, you could also provide certain members more than one vote if they’re more involved in the company’s operation.
Although we briefly mentioned income above, you need to state the compensation for all managers and members in an LLC operating agreement. The last thing you want to encounter is an argument over how each person receives their share of the company’s profits.
You can list it out by an equal percentage among members. Or, you might decide to split income unevenly and base it on each member’s voting rights or involvement with day-to-day operations.
LLC Ownership Transitions or Exit Plans
When you create an LLC operating agreement, you want to include how to transfer the business when a member exits the company. Laying out transition rules is one of the most important parts of your operating agreement. Leaving this to chance might cause you to lose control of your company in the future.
You need to identify what happens in the following situations:
- When a member decides it’s their time to leave the company
- When a member passes away
Think through both scenarios carefully and hold discussions that force the company to write transition and exit rules. If you don’t address these situations in your operating agreement, it could create future problems or even lead to lawsuits.
The death of a member is an example of a potential lawsuit. That member’s family may think they’re due more than their fair share of the company if you don’t have the transition rules laid out clearly in the LLC operating agreement.
Taxes and Other Financial Considerations
Include a section in your LLC operating agreement with all-important tax rules that will affect how the business runs each year. You might have a flat rate for taxes, for example. It could also fluctuate depending on whether you’re making profits as an individual entity, partnership, or corporation.
For instance, if you’re filing taxes as a partnership or corporation, different tax rules exist that dictate how to distribute profits and losses. Some LLCs need to pay self-employment taxes, although they don’t file income through an individual owner’s return. Make sure you address all the possible scenarios so your company doesn’t run into any problems in the future.
There are two main parts to include in an LLC operating agreement when discussing meeting rules. The first part is how often you’ll hold meetings. It also lists who has the power to call one when they feel it’s necessary. Some companies might meet once per quarter. Others do it monthly or annually, depending on what they think works best for everyone involved.
The second part is how to run each of the meetings. You need to specify if all members need to make themselves available for a meeting. Or, in the case of an LLC with multiple managers, you might not make it a requirement for all members to attend every single meeting.
Contracts and Agreements
You should never enter into any business transaction without first consulting your LLC operating agreement. A contracts and agreements section will cover what you can and cannot do as a member. Doing so puts everyone on the same page. It prevents any member from getting other members in legal trouble down the road.
You want to make sure you list any contracts or agreements that your LLC could enter into. Examples might include car lease agreements or real estate contracts. It’s also a good idea to specify how specific business deals get made. Can any types of arrangements get made with the consent of one manager, a majority of managers, or is a unanimous vote required?
Example of an Operating Agreement
Several websites exist where you can see complete examples of LLC operating agreements. These sites will often have free templates you can use to create the operating agreement for your LLC.
Remember that you need to match an operating agreement to whether you’re running a single-member LLC or multi-member LLC. Here are three websites to visit where you can view operating agreement examples.
e-Forms.com allows you to choose your state, click a button, and create the operating agreement. The website also includes separate pages for creating a single-member LLC operating agreement and a multi-member LLC operating agreement.
LawDepot.com uses a similar feature where you can choose your state and immediately see an operating agreement example that pertains to your specific needs.
On this page at FindLaw.com, you can see an operating agreement example before making any decisions about setting up your particular document. You’ll notice that this example lays out the following information for you to view:
- Company Information (Company name, address, state of formation, members, and registered agent)
- Governing Agreement
- Limitation of Liability
- Company Management
Is an LLC Operating Agreement Required?
Most states don’t require an operating agreement for a limited liability company. The following states do require that your LLC creates one:
- New York
However, we highly recommend having this type of business document even if your company exists in a state where it isn’t legally required. Remember, the LLC operating agreement protects the interests of each member. It avoids disagreements or scenarios where the principal owners can lose interest in the company.
When starting a new LLC or running one with multiple partners, the last thing you want is confusion over what everyone’s roles are, who can sign contracts, how to endure transitions or deaths, and who can make other important decisions by themselves.
What if I Don’t Have an Operating Agreement for My LLC?
You’re inviting problems and potential disasters if you decide to operate your LLC without an operating agreement. How will you run the company in an orderly fashion without one? How will you avoid major arguments that erupt because rules don’t exist for making important decisions?
If you don’t have an operating agreement in place, your company could face lawsuits. These lawsuits can happen, for instance, if someone claims that another member wronged them by making significant decisions without obtaining consent from the rest of the members.
Entering into contracts becomes a problem if an operating agreement doesn’t guide your LLC. One member can enter into contracts without the agreement of other members. You can get yourself into a legal mess, for example, if another member enters into a lease without the knowledge of all members.
You don’t want to put yourself in these types of positions when you can so easily avoid it by creating an operating agreement upfront.
How Do You Create an LLC Operating Agreement?
You don’t necessarily need to hire a lawyer to create the operating agreement for your limited liability company. You can use online software or LLC legal form websites that provide you with the proper agreements. Fill in your specific information into these documents and include the agreement in the company’s LLC binder.
On the other hand, you might want to hire an attorney, so you’re sure that your operating agreement gets the approval of a professional. A lawyer well versed in this area can also help you and the other members think through scenarios to include in the agreement. Some of the best LLC formation services offer this service as well.
The Last Word
It’s time to make the decision for your LLC about whether you’ll create an operating agreement. Weigh the pros and cons of including the agreement for your company. Talk with all members involved with your company. Each member will likely agree to write up an LLC operating agreement to protect the interest of everyone involved with the business.
Questions? Let us know.
Filed under: Advice Columns