What Is an LLC Operating Agreement?

An operating agreement for a limited liability company (LLC) is an important legal document that details who owns the business and also provides essential information pertaining to member duties. An LLC operating agreement establishes the financial relationship between business owners (“members”) and the basics of the working relationships between those owners and the managers who oversee daily operations. 

It must be noted the terms “owners” and “members” are used synonymously in the context of LLCs. However, LLC members are distinct from managers who run the business. Let’s take a closer look at what LLC operating agreements are all about.

Why LLC Business Owners Need an Operating Agreement

While not required in some states, an LLC operating agreement is similar to a form of insurance in that it provides legal and financial recourse for a number of situations. If conflicts arise between LLC owners pertaining to any of the following issues, the operating agreement will provide clarity.

The specific language of the operating agreement details exactly how such conflicts will be resolved. This document details how the business is structured, the dynamics of operations, and more. 

Though certain states have default rules on the books that address some of the potential challenges that might arise between LLC members, the LLC operating agreement has the potential to override such presumptions.

What to Include in an LLC Operating Agreement

The operating agreement should contain information pertaining to LLC management roles, voting, capital contributions, membership, and additional topics as detailed below. The specific information included in your LLC operating agreement will hinge on the nuances of your business. 

In general, operating agreements typically detail members’ percentage of LLC ownership, as well as the sharing of profits and losses, in the distributive shares section. 

Distributive shares are typically allocated in the same manner as each owner’s percentage of ownership. For instance, a member with 10% business ownership will receive 10% of profits. However, there is no law that states the share of ownership has to be exactly the same as the distributive share percentage. 

The agreement should explicitly state whether owners of the LLC are permitted to draw money from profits whenever desired or if distributions will be made at specific times. Though it seems logical for each member to have one vote, it is possible to align voting power with percentage of LLC ownership. It’s a good idea to think long and hard about how your ownership group will handle voting before agreeing to the details of voting rights. 

The LLC operating agreement must also contain language pertaining to shifting ownership. LLC owners need a clear plan in place so ownership can seamlessly transition in the event of a death, retirement, or decision to sell. The agreement should detail the rules that will apply should a member depart the business for any reason.

Operating Agreement vs. Articles of Organization

An LLC operating agreement is different from the articles of organization, which is the public document you file with the state to form your LLC. All of the LLC’s basic information is contained within the articles of organization, including:

• Company name
• Management approach
• Registered agent’s name and address

LLC operating agreements provide more information, detailing how the LLC is to be managed and the member rights, liabilities, duties, and so forth. Furthermore, unlike the articles of organization, the operating agreement is private as opposed to public.

Don’t Start an LLC Without an Operating Agreement

Most states require LLCs have an operating agreement in place, though some state laws governing LLCs state that the operating agreement can be implied, written, or oral. In these cases, if there is no written nor oral operating agreement, the state assumes the LLC members wish to have default provisions govern them and their business. 

To find out the requirements for drafting an operating agreement in your state, choose a state from the list below. You will find all the specifics and information you need for your business.

Instead of putting your faith in such default provisions, it’s better to be proactive by creating an operating agreement approved by each member.

It’s also a good idea to refuse a verbal or implied agreement even if the other LLC members believe such an agreement will suffice. LLC should put in place a formal written operating agreement that spells out the rules, procedures, and other details of how conflicts will be resolved. 

Keep in mind, even if you and the rest of your LLC members are in agreement on everything today, you may not see eye-to-eye on all matters down the line. If you don’t have a formal written LLC operating agreement in place, you and fellow members of your LLC will be subjected to supposedly fair and just rulings as dictated by the language of state statutes. 

But it’s wise not to let such statutes determine your financial fate, as their language tends to be confusing and unclear. Instead, move forward with an LLC operating agreement written by your trusted business law attorney.

The LLC Operating Agreement Is an Opportunity to Futureproof Your LLC

No one can predict the future, especially when it comes to the highly competitive business landscape. 

One of your LLC members could become ill or incapacitated. Your LLC might be the target of an aggressive takeover attempt by a larger corporation. Perhaps conflicts will arise between LLC owners pertaining to how the business is managed or whether it will expand to new locations. 

The moral of this story is that plenty that can go wrong in the months and years ahead. An LLC operating agreement helps members overcome such obstacles, even if they are completely unpredictable.

Sweat the Small Stuff of Your LLC Operating Agreement

It could be a grave mistake to print an LLC operating agreement template from the web and fill in your LLC and member information. 

Your LLC operating agreement should be tailored to the specifics of your LLC, as a generic operating agreement might have vague language that could expose its members to a successful legal challenge. 

Your LLC operating agreement must be extensively detailed, containing information such as:

• How the LLC will be managed
• How management is selected
• Member responsibilities
• How business decisions will be made

Truly comprehensive LLC operating agreements detail how the LLC will be managed in terms of whether members or a manager are put in charge. The LLC operating agreement details should extend to the actions required of a member. Even the specific percentage of votes necessary for approval should be identified. 

The best LLC operating agreements consider events that could cause the dissolution of the LLC, so it’s generally a good idea to meet with a business attorney to address such potential events in your operating agreement. 

This lawyer could also ensure your operating agreement details how profits are to be allocated to members and outlines procedures for adding members or transferring ownership interest.

Creating an LLC Operating Agreement is not a DIY Project

The do-it-yourself ethos certainly has its merits, but it may be unwise for a project as important as creating an LLC operating agreement. Resist the temptation to use a web template for your operating agreement. 

Instead, do the smart thing by consulting with a business attorney who has experience drafting, reviewing, and amending LLC operating agreements. 

A business attorney knows exactly how this legal contract should be written to protect your interest. Unlike templates available on the web, LLC operating agreements created by attorneys specifically tailor the language to the business in question and incorporate the state’s rules governing how businesses operate. 

Plan for the Worst and Hope for the Best

The top business attorneys brainstorm potential scenarios that might arise down the line and plan for them by shaping the operating agreement’s language as necessary. 

Comprehensive LLC operating agreements created by experienced attorneys detail each member’s management and financial rights. This is the type of specificity that simply cannot be achieved with a basic LLC operating agreement printed from the web. 

Such templates are typically outdated, lack important language, and generically explain member rights in a manner inapplicable to the nuances of the average LLC. 

LLC operating agreement templates on the web often have missing information that renders the operating agreement null and void, or at least partially meaningless. 

As an example, if your LLC operating agreement does not have extensive information pertaining to how conflicts will be resolved, you might end up spending a considerable amount of time and money pursuing litigation.

Have an experienced business law attorney spearhead the creation of your LLC operating agreement or at least review such a proposed agreement on your behalf and you will move forward with your LLC in full confidence. 

The last thing you want is for a supposedly bulletproof LLC operating agreement to contain a litany of errs that set the stage for you to lose your stake in the business or receive a smaller share of the profits. 

The little bit of money you spend for the guidance of a savvy business attorney to create or review your LLC operating agreement will pay for itself in due time, as it will prevent costly litigation and financial losses that could have been prevented with a well-written LLC operating agreement. 

Don’t Let Your LLC Operating Agreement Collect Dust

Once your LLC operating agreement is in place, make several copies. Keep one for your business records, hand one to your attorney and keep a third in storage for safekeeping. 

It’s a mistake to simply stop thinking about your LLC operating agreement once it is completed, approved, and out of sight. This crucial business document should be reviewed at least once a year to verify it accurately reflects member wishes and the current state of the business.

If your business has significantly changed, if a member has passed away, or if a member’s desires in the context of the LLC have changed, meet with your business attorney to have the LLC operating agreement amended.