Understanding Operating Agreements

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Operating Agreements: Key Elements You Need To Know

For every business, there needs to be a document that lays out the rules and answers the most critical questions. If your company is an LLC, this document is your operating agreement. This document is critical for all LLCs, even those with just one member, especially if you operate in a state that requires you have one on record.

Of course, an operating agreement must have certain key elements included for it to be effective. So, what items would a contract attorney include in an operating agreement?

Equity Structure

The equity structure must cover the following elements.

  • Membership Interest: This is expressed as a percentage interest. Membership should be made up of two components: economic and management. It should be clarified how this can change as new members are added and if there are different classes of membership interest, this must be clarified as well.
  • Capital Contributions: Capital contributions can include cash, property, services, promissory notes, or any other obligation that either contributes capital or services. If a member is contributing something other than money, the value of that contribution should be clearly outlined. It must also be clarified if someone is making a one-time contribution or if it is expected that their capital will be regularly given.
  • Allocation of Profits, Losses, and Distributions: The operating agreement must allocate each of these units with their own economic rights based on the class of the member. It can also specify cases in which this allocation structure can be altered. For example, someone with 50 percent interest in the LLC may get 95 percent of the profits in a given year if they happened to contribute extra capital.

Management

An LLC has two options for management. The first is for it to be managed by the members, and the second is to bring in independent management. This portion of the operating agreement should specify who will run the LLC, how often meetings must be held, the duties of each manager, the length of term served, and what must be done for a manager to be removed.

Voting

The agreement should outline the standard rules for voting and clarify how many votes each member gets, usually tied to their percentage of interests. Depending on the circumstances, it might be necessary that the agreement withhold the voting rights of a member or member class. If certain members will be given veto rights, this should be clarified.

Liquidation and Dissolution

Here, the agreement must clarify who can decide to dissolve the LLC and on what grounds. Also, you can note specific events that automatically trigger dissolution. It should outline how assets will be liquified and divided upon dissolution.

Getting an Operating Agreement That Works for You

An iron-clad operating agreement will usually run 30 pages or more, which means drafting it on your own will take a lot of time and give plenty of room for error. Instead of going DIY, connect with contract lawyers near you. Contracts Counsel is a boutique marketplace that features vetted lawyers who fully understand the unique needs of LLCs. Protect your company with ContractsCounsel.com.

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