An LLC operating agreement isn’t required in most states, but it’s an important legal document for a business.
Priyanka Prakash
Priyanka Prakash is a former Fundera.com staff writer and a freelancer specializing in small-business finance, credit, law and insurance, helping business owners navigate complicated concepts and decisions.
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MORE LIKE THIS Business Legal Small BusinessAn LLC operating agreement can serve as a directive for a limited liability company, outline the responsibilities of the owners (called members) and protect the owners from being personally liable for business operations. Although it’s not legally required by every state, it is prudent to keep an operating agreement, even for single-member LLCs.
An operating agreement is a legal document, essentially a contract, that outlines the internal structure of an LLC and provides details about how the business will be managed, the rights and responsibilities of each member, how members will be paid, and procedures in case of dispute among members or dissolution of the company. Once an agreement is drawn up, it’s signed by each member of the LLC.
An operating agreement is specific to an LLC — with companies structured as C- or S-corps, this document is referred to as corporate bylaws.
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ZenBusiness Starting At Read ReviewOnly five states — California, Delaware, Maine, Missouri and New York — require LLCs to have an operating agreement before selling any products or services. With the exception of New York, which specifically requires a written operating agreement, all of these states allow the agreement to be oral. In these states, even single-member LLCs must have an operating agreement.
Even though an operating agreement isn’t required by the vast majority of states, it can provide guidance for the future of the business and protect owners from being held personally liable for a business. It also details the organization of your company for lenders or potential investors, many of whom will request an operating agreement before giving capital to your business.
Unless you have a legal background, it’s recommended you don’t try to draft an operating agreement from scratch. For simpler situations, you can use a template or an online legal service, like LegalZoom or Rocket Lawyer.
For more complicated situations, and especially if there are more than two members, you may consider enlisting the help of a business lawyer. Many lawyers will help you file articles of organization and write up your operating agreement for a flat fee.
Generally, the steps to create an LLC operating agreement are as follows.
The LLC operating agreement should show what each owner has contributed to the business and the value of each contribution, whether it’s capital, property, skills, labor, intellectual property or other resources. Each contribution should correspond to an ownership interest (also called ownership percentage) in the business.
Member compensation depends on each member’s role within the business and how the LLC elects to pay taxes. If the LLC is taxed as a corporation, members can receive a salary for their work in the business, along with distributions. If the LLC is taxed as a disregarded entity, members will only receive distributions based on their ownership interest in the company.
LLCs can be either member-managed, where members run the daily operations of the business, or manager-managed, where outside managers are brought in. If it is manager-managed, the agreement should detail a manager’s responsibilities, salary and tenure of employment. The method for terminating employment of a manager and electing a new one should also be provided.
Once the management structure has been determined, the operating agreement should also outline the roles of each member, including their voting rights. The voting provisions should clearly outline the voting share of each member — usually equal to their ownership interest. It should also specify whether a simple majority is sufficient to finalize a vote. In a manager-managed LLC, it should be clear when members must step in and approve manager actions.
Once the voting rights have been established, this section may provide a broad overview of each member’s role. If outside managers are hired, this section should detail their day-to-day responsibilities.
The LLC operating agreement should also address the process for dissolving the business, usually triggered by a member vote, including filing appropriate forms with the state, liquidating assets, paying creditors and more.
Once the overall structure of the agreement has been made, there are additional details that should be included. Generally, the basic information that’s included in your articles of organization filed with the state will be included in your LLC operating agreement, including the company name plus any fictitious business names or DBAs , the company address, and the name and address of the registered agent.
Along with basic company information, your LLC operating agreement should contain information about each member and manager, including their name, address, title, job responsibilities and ownership percentage.
In addition, the LLC operating agreement should include:
Business purpose. A line or two about the business’s industry and primary product or service. This may also include a line that permits the business to engage in any lawful purpose, giving the business freedom to pivot later.
Statement of intent. This statement specifies that the operating agreement conforms to the LLC laws of your state and that after all of the proper documents have been filed, the business will come into existence.
Duration of the business. Unless your LLC is set up for a specific project or time frame, like a joint venture, for example, this section would include a brief statement that allows the LLC to continue in perpetuity.
Tax treatment. By default, LLCs are taxed as partnerships or disregarded entities (single-member LLCs). However, LLCs can elect to be taxed as S-corps or C-corps by filing forms with the IRS. You should indicate your LLC’s preferred tax treatment in the LLC operating agreement.
Member meetings. LLCs aren’t legally required to hold meetings in the same way that corporations must do for their shareholders and directors; however, most LLC operating agreements schedule periodic meetings to vote on important matters. The agreement should summarize the time, place and manner of the meetings, as well as the purpose of each meeting.
New members and exit rights. The LLC operating agreement should outline the process for the entry and exit of LLC members. Most LLC operating agreements grant a right of first refusal to existing owners to purchase outgoing owners’ interests so that members retain close control over the business.
Much of your LLC operating agreement will depend on your individual business and industry. This being said, in addition to the provisions reviewed above, there are a handful of other provisions you might see (or want to include) in your agreement:
Liability statement: This language specifies that the LLC members have limited liability protection as members.
Death of a member: This provision would detail the procedure that takes place in the event that a member passes away.
Dispute resolution: What happens if there’s a dispute amongst members? This provision would outline the process to follow.
Communication: How are important notices about the business communicated? This provision details how information is transmitted amongst members.
State law: This provision simply identifies the state law that governs the LLC.Special agreements: Some LLCs may wish to include non-compete agreements, conflict of interest policies and other specialized agreements as part of their operating agreement.
Even if it’s not required in your state, an operating agreement provides a lot of key benefits for your business.
One of the benefits of choosing an LLC business structure is the protection from personal liability — meaning your personal credit and assets are protected if anything with the business goes awry. An LLC operating agreement solidifies the legal separation between the members and the business operations, reinforcing this protection. This separation is particularly important for single-member LLCs.
In the absence of an LLC operating agreement, the state’s default rules kick in, which means your LLC will be subject to how the state approaches management, admission of new members, dissolution, profit distribution and more. Creating your own LLC operating agreement will override these rules.
An LLC operating agreement contains clear provisions about each owner’s contributions to the business, their share of profits, and their responsibilities to the company and other members. It can serve as a reference to resolve any potential conflicts and provide clarity about the direction of the business for the members themselves and potential investors or lenders.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.
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