An LLC Operating Agreement is a contract that outlines who owns an LLC, how much of the LLC they own, how taxes are paid, how the LLC is managed, and more. This document also establishes protocols for keeping the business organized and functioning smoothly. The Operating Agreement may be amended as the business grows and changes.
An LLC Operating Agreement is not required in every state, but it is highly recommended. Even if your state does not require an LLC Operating Agreement, drafting one is beneficial in making sure you’re treating your LLC as a separate legal entity.
Types of LLC Operating Agreement
There are two main types of LLC Operating Agreements:
- Member-managed LLC: A Member-managed LLC is an LLC that is managed by its owners. This type of LLC is the most common, and is typically used for businesses with a small number of owners.
- Manager-managed LLC: A Manager-managed LLC is an LLC that is managed by one or more designated Managers. This type of LLC is typically used for businesses with a large number of owners or where certain Members (owners) will take a passive role and they will not manage the company.
Why Do You Need an Operating Agreement?
If you are forming an LLC with one or more people, it is important to have an Operating Agreement. Even if you are the only member of your LLC, having an Operating Agreement can help to solidify your legal status as a separate business entity.
Without an Operating Agreement, your LLC will be governed by the default rules outlined in your state’s LLC statutes. These default rules may not be ideal for your business and may not reflect how you intend to run your LLC.
An Operating Agreement can provide greater flexibility and certainty than the default rules. For example, an Operating Agreement can specify how the LLC will be managed, how decisions will be made, what happens if a member leaves the LLC, and what happens if the LLC is dissolved.
In some cases, having an Operating Agreement may also help to shield you from personal liability for the debts and liabilities of the company.
An LLC Operating Agreement can also help if you bring on investors or partners. This is because the Operating Agreement can establish the LLC as a separate legal entity and clarify what happens in these scenarios. An Operating Agreement also gives your business greater credibility.
What Should Be Included in an Operating Agreement?
The specific provisions of an LLC Operating Agreement will vary depending on the needs of the LLC and the state in which it is formed. However, there are some common elements that should be included in all Operating Agreements.
Management Structure
One of the most important aspects of an LLC Operating Agreement is the management structure. The management structure will determine who has the authority to make decisions on behalf of the LLC, how those decisions are made, and what happens if there is a disagreement among the members.
LLCs have two main types of management structures: Member-managed and Manager-managed.
In a Member-managed LLC, all members have the authority to make decisions and take action on behalf of the company. This type of structure is often used for LLCs with only a few members – who are all actively involved in running the business. And this is the most common type of LLC management structure.
In a Manager-managed LLC, one or more designated members (called Managers) have the authority to make decisions and take action on behalf of the company. The other members are typically not involved in the business’s day-to-day operations. This structure is often used for LLCs with multiple members, some of whom may be passive investors.
The management structure of an LLC should be specified in the Operating Agreement. If no specific management structure is outlined, the LLC will typically be considered member-managed by default (but it depends on the state’s LLC Act).
Voting Rights
Another critical aspect of an LLC Operating Agreement is the voting rights of the members. The voting rights will determine how decisions are made and how they are resolved.
There are two main types of voting structures for LLCs: unanimous consent and majority vote.
Under the unanimous consent model, all members must agree for a decision to be made final. This type of voting structure is often used for LLCs with only a few members actively running the business.
Under the majority vote model, a decision can be made if it is approved by more than 50% of the members. This type of voting structure is often used for LLCs with multiple members.
The voting rights of the members should be specified in the Operating Agreement. If no specific voting rights are outlined, the LLC may be considered a unanimous consent company by default (but it depends on the state’s LLC Act).
Dissolution
Another important provision to include in an LLC Operating Agreement is a dissolution clause. This clause should specify what happens if the LLC is dissolved or wound up for any reason.
There are two main types of dissolution clauses: voluntary and involuntary.
A voluntary dissolution clause allows the members to agree to dissolve the LLC at any time and for any reason.
An involuntary dissolution clause allows the LLC to be dissolved if certain events occur, such as the death of a member, or the company’s bankruptcy.
The dissolution clause should be specified in the Operating Agreement. If no specific dissolution clause is included, the LLC will be subject to your state’s laws regarding LLC dissolution.
Distribution of Assets
Another important provision to include in an LLC Operating Agreement is a distribution of assets clause. This clause should specify how the LLC’s assets will be distributed if the company is dissolved or wound up for any reason.
There are two main types of asset distribution clauses: equal distribution and unequal distribution.
Under the equal distribution model, the assets of the LLC will be distributed evenly among all members.
Under the unequal distribution model, the assets of the LLC will be distributed according to each member’s ownership percentage.
The distribution of assets clause should be specified in the Operating Agreement. If no specific asset distribution clause is included, the LLC will be subject to the laws of your state regarding the distribution of assets in an LLC.
Amending the Operating Agreement
An LLC Operating Agreement can be amended anytime and for any reason. However, it is essential to specify how the Operating Agreement can be amended in the agreement itself.
There are two main amendment clauses: unanimous consent and majority vote.
Under the unanimous consent model, all members must agree to an amendment for it to be made.
Under the majority vote model, an amendment can be made if it is approved by more than 50% of the members.
The amendment clause should be specified in the Operating Agreement. If no specific amendment clause is included, the LLC will be subject to the laws of your state regarding amendments to LLC Operating Agreements.
Other Provisions
In addition to the above provisions, there are a few other provisions that should be included in all LLC Operating Agreements. These include:
- A clause specifying the date on which the agreement will take effect.
- A clause specifying the duration of the agreement (i.e., how long it will remain in effect).
- A clause specifying the jurisdiction in which the agreement will be governed.
- A clause specifying the venue for any legal disputes that may arise under the agreement.
- A clause designating who the Registered Agent is. For example, if you form an LLC in Texas, your Operating Agreement would list the registered agent in Texas you designated.
These clauses are essential in protecting the interests of all parties involved in the LLC. Including them in your Operating Agreement will help to avoid any misunderstandings or disagreements down the road.
How to Create an Operating Agreement
There are a few different ways that you can go about creating an Operating Agreement for your LLC. You can:
- Hire an attorney to draft the agreement for you
- Use an online template or service
- Draft the agreement yourself (with input from an attorney, if desired)
If you choose to hire an attorney to draft the agreement for you, they may either use a standard template they have used in the past for other clients. Or they can customize one, depending on your LLC’s needs.
If you choose to use an online template or service, select one specific to your state’s laws.
If you choose to draft the agreement yourself, there are a few resources that can help you to do so:
- The Small Business Administration (SBA) has a sample Operating Agreement on its website.
- You can find numerous templates and samples online by searching for “LLC University LLC Operating Agreement” or “LLC Operating Agreement template”.
Once you have drafted the agreement, you may want to have it reviewed by an attorney to ensure that it is legally binding and compliant with your state’s laws. Once the agreement has been finalized, each member of the LLC should sign it and keep a copy for their records.
You don’t have to file your LLC Operating Agreement with the State
Once you have created your LLC Operating Agreement and the Member(s) have signed, there’s nothing else you need to do.
LLC Operating Agreements are “internal documents”. Meaning, you don’t need to send a copy to the Secretary of State, the IRS, or any other agency. You’ll just want to keep a copy with your business records. That can be a physical copy or you can scan and save a copy on your computer.
You should also update the agreement as needed to reflect any changes to the LLC, such as the addition or removal of members.
If you have any questions about filing your LLC Operating Agreement, you can consult with an attorney who is familiar with LLCs in your state.
Matt Horwitz is the founder of LLC University, a website that teaches people how to form LLCs. Matt is the leading authority in LLC education and is featured in CNBC, Yahoo Finance, Entrepreneur Magazine, and US Chamber of Commerce. Matt holds a Bachelor's Degree in business from Drexel University with a concentration in business law. LLC University®, established in 2010, was the first company to create free LLC courses in all 50 states.