An operating agreement is a legal document used by limited liability companies (LLC) that outlines the internal operations and management structure of the company. It establishes the rights, responsibilities, and relationships of the LLC's members and managers and covers issues like ownership, voting rights, profit and loss distribution, decision-making processes, and dispute resolution.
What Should be Included in an Operating Agreement?
Operating agreements must include detailed provisions that govern the operation and management of an LLC. While the details of an operating agreement will vary based on the company, the following provisions are typically found in a standard LC operating agreement:
- Company information. The legal name, address, and purpose of the LLC.
- Member information. Members names, ownership interests, and capital contributions.
- Management structure. An LLC can be member-managed, which allows all members to have authority to manage the company, or manager-managed, in which members appoint managers to handle day-to-day operations.
- Voting rights and decision-making. How voting rights are allocated among the members and detailed procedures for decision-making, meetings, and voting.
- Profit and loss distribution. How profits and losses will be distributed among the members based on their ownership interests or other agreed upon terms.
- Transfer of ownership interests : Circumstances under which members can transfer or sell their ownership interests including any restrictions or rights of first refusal.
- Dissolution and liquidation. The process for dissolving the LLC and distributing its assets upon dissolution.
- Management and member duties : The rights, responsibilities, and fiduciary duties of managers and members.
- Dispute resolution. Provisions for resolving disputes like the use of mediation or arbitration.
If you are unsure what to add into your LLC’s operating agreement, it is recommended that you consult with a business attorney to ensure that the operating agreement is properly drafted and reflects the interests of the LLC and its members.
What is the Purpose of an Operating Agreement?
The purpose of an operating agreement is to create a legal document that outlines the way an LLC is governed and run.
Some key purposes of an operating agreement include:
- Establishing the rights, responsibilities, and relationships between the LLC members and the managers.
- Documenting a set of rules and procedures that all members and managers will be required to abide by.
- Establishing voting rights and decision-making procedures within the company.
- Protects the members’ interests and ensures that every member is treated fairly.
An LLC operating agreement acts as a contract between all the members of an LLC, and the members must adhere to the contract terms.
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What to Look for in an Operating Agreement
When reviewing an operating agreement, there are specific details that you should look for to ensure that the document is drafted correctly and protects the interest of the members, managers, and the company.
During review, ensure your operation agreement addresses the following issues:
- Decision making procedures like voting requirements for members
- A clearly defined management structure
- How a member can transfer ownership interests
- How to dissolve the LLC
- Dispute resolution procedures
In addition, always make sure that the operating agreement complies with all state and federal laws and regulations that govern businesses.
Are Operating Agreements Required?
Operation agreements are only required by law if your LLC is established in one of the following states:
- California
- New York
- Missouri
- Maine
- Delaware
While most states don’t mandate the drafting of this document, it is highly recommended that every LLC, especially multi-member LLCs have a well-drafted and legally enforceable operating agreement.
Can I Create My Own Operating Agreement for My LLC?
Yes, it is possible to draft your own operating agreement for your LLC; however, this is not always recommended. If you live in a state that requires operating agreements or are a member of a multi-member LLC, it is highly recommended to consult a business lawyer for operating agreement drafting or review services.
An experienced attorney can draft a custom operating agreement or review an operating agreement that you have drafted yourself. This ensures that the document contains all necessary clauses, follows all applicable laws, and best protects the business and its members.
Single Member LLC Operating Agreements
A single-member LLC is an LLC that is owned and operated by a single person or entity. Even though it might not seem important to have an operating agreement if you are running your owner business as a solo operation, there are some reasons why you still may want to create this legal document.
- Maintain limited liability protection. An operating agreement serves to help establish the LLC as its own legal entity. This will help maintain the limited liability protection offered by an LLC.
- Banking and finance. Many banks and financial institutions require a single-member LLC to have an operating agreement to open a business bank account or obtain business loans. Without this document, an LLC may have limited financial options.
- Future planning. Even if you start your business as a single-member LLC, you may have plans to add members and grow your company. A standing operating agreement can dictate how members will be added and provide structure while growing your business.
Multi-Member LLC Operating Agreements
A multi-member LLC (MMLLC) is an LLC that is owned and operated by two or more individuals or entities. If you run a multi-member LLC, it is highly recommended that you have a valid and comprehensive operating agreement because it works as a guide for all members to follow. Additional reasons for an operating agreement for an MMLLC include:
- Protection of member rights. An MMLLC operating agreement will identify all members and specify their ownership percentages or capital contributions. This provides each member with protection and ensures they will be treated fairly.
- Guidance for voting and decision making. With multiple parties contributing to the business, there needs to be a way to fairly make important business decisions. The operating agreement will include voting procedures and how the members make decisions regarding admitting new members or large financial transactions.
- Guidance for dispute resolution. Disputes are bound to arise when various individuals are running a company. The operating agreement will clearly lay out procedures for solving disputes and may require mediation or arbitration to avoid costly litigation.
Operating Agreement vs. Articles of Organization
Operating agreements and articles of organization are both important formation documents for an LLC, but they serve two very different purposes. While an operating agreement serves as an outline or guide of how to run the company, articles of organization establish the company as a legal entity.
To establish a legally recognized LLC, the company owner must file articles of organization with the Secretary of State and pay a required filing fee. Each state has a different filing process and fee, so it is important to contact your local state government for the requirements to establish your new LLC.
Articles of organization will include basic information about the LLC like the company name, the registered agent, and the principal place of business. Once the articles are filed, this information becomes a public record and allows the LLC to function as a legally recognized business.
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