Forming a limited liability company (LLC) marks the first step in the journey of many entrepreneurs and small businesses. Doing so protects owners and their assets from liability for business debts, legal burdens, and financial obligations.
An LLC operating agreement serves as a foundational legal document that defines how your limited liability company will operate. It’s only mandatory to draft one if you are incorporated in one of the five states with such laws. Yet, even if you aren’t obliged to have an operating agreement for your company, it’s still an extremely important contract that can provide significant benefits in the long run, especially for multi-member LLCs.
In this article, we’ll take a deep dive into LLC operating agreements, their purpose, and benefits. You’ll also learn what to include in the contract and how to draft one for your business.
What Is an LLC Operating Agreement?
An LLC operating agreement is a legal document that sets out the terms of your limited liability company in accordance with your and your fellow members’ specific needs.
An LLC operating agreement outlines the financial and functional decisions, including the rules, regulations, and provisions, to govern your business’s internal operations. It also defines the key aspects of the company, such as its purpose, profit distribution, ownership structure, and members’ rights.
In most cases, an operating agreement for the LLC is drafted after the business entity’s formation and the filing of an articles of organization or a certificate of formation. Based on the number of members, the contract has two primary types:
- Single-member LLC operating agreement: A single-member LLC operating agreement is created for a limited liability company where you are the only owner. Despite that you don’t need to coordinate with other members to manage the business, it’s still advised to draft the contract to ensure legal protection, safeguard your personal assets, comply with state laws (if applicable), and onboard potential partners.
- Multi-member LLC operating agreement: You should draft a multi-member LLC operating agreement when your limited liability company has more than one owner. While it’s only mandatory in a few states, having a contract for a multi-member LLC is essential to minimize the chances of disputes, establish ownership structure, clarify roles and responsibilities, ensure legal protection, and customize profit distribution.
Do I Need an Operating Agreement for My LLC?
Drafting an operating agreement for your LLC isn’t mandatory in most US states. The only exceptions are California, Maine, Missouri, New York, and Delaware, where it’s legally required to have the document written and signed by all members of your limited liability company.
But even if the state you are incorporated in doesn’t require you to have one, you should still consider drafting an operating agreement for your LLC. The primary benefit of doing so is that you can set your own terms, conditions, and provisions for running your company.
Without a fully signed operating agreement, the default rules of the state of incorporation will apply to the LLC’s operations. Default LLC rules vary by state, and many are too vague or general to fit the unique preferences of your company’s owners.
For instance, some US states may require the members of your LLC to share all profits equally, even if there’s a massive discrepancy in the capital contributions of each owner. You can avoid such an unfair situation by signing a limited liability company operating agreement with your partners after the business’s formation.
Another important benefit of an operating agreement for your LLC is that you can secure your and other owners’ liability protections. A well-drafted contract minimizes the chance that the corporate veil gets pierced in a legal battle, which would make you personally liable for business debts.
An operating agreement also provides much-needed clarity about your LLC’s operations for involved parties. This establishes a formal structure for the company and clarifies important matters related to profit-sharing, decision-making, and how the business is run overall.
For multi-member LLCs, the contract establishes owners’ rights and responsibilities and protects the interests of each member. It also reduces the chances of internal disputes and facilitates their seamless resolution by setting out basic governing principles.
In addition to the above, banks may require an LLC operating agreement to open a business account at one of their branches and access their corporate offerings. Potential investors or partners may also ask for the same document to understand your company’s structure before investing capital or signing a deal with your organization.
What to Include in an LLC Operating Agreement
In addition to basic company details and information about members, a typical LLC operating agreement includes the following terms, conditions, and provisions:
1. Statement of Intent
In the context of limited liability companies, a statement of intent explains that your LLC’s operating agreement was drafted in accordance with the laws and regulations of the state and that the business will be established after the official formation documents are filed with the state.
The statement of intent should also briefly describe the purpose of your limited liability company and the nature of your business.
2. Ownership and Management Structure
In the operating agreement, you should also describe the management and ownership structure of your LLC.
Regarding the latter, you should list the ownership percentage of each member in the LLC—for example, you own 60% and your partner 40% of the business. If you have a single-member limited liability company, you should only include yourself with a 100% LLC ownership percentage in the operating agreement.
Generally, LLCs can have two types of management structures:
- Member-managed LLC: Here, the members of an LLC actively manage the company as both their owners and the managers of its day-to-day operations. This management structure best suits small LLCs with a single or a limited number of members and streamlined processes.
- Manager-managed LLC: A manager-managed LLC is operated by a group of individuals elected by the owners of the company. While you still exercise your voting rights on important decisions, you and your partners fulfill a passive role in the business’s day-to-day management. The manager-managed LLC structure might be a good fit for companies with several owners and complex operations.
3. Liability Statement
It’s advised to include a liability statement in your LLC’s operating agreement to properly define the company’s limited liability status.
While an LLC is designed to protect you and your partners from liability for business debts, there’s still a chance the corporate veil might get pierced in court. However, with a clear liability statement, you can declare your limited liability status in the operating agreement and ensure that you continue maintaining it even after it gets challenged in a legal case.
4. Rights and Responsibilities
The operating agreement should set out the rights and responsibilities of each member of the LLC.
These should align with the chosen management structure (member-managed or manager-managed LLC) and clearly outline owners’ voting rights and voting share. In most cases, each member’s voting share should equal or at least reflect their ownership interest.
In addition to the general overview of member roles and manager day-to-day responsibilities, this section of the LLC operating agreement should determine the percentage of votes needed to approve and finalize company matters. If your limited liability company is operated by managers, the contract should also outline when owners’ approval is necessary for managers’ proposals.
5. Profit-Sharing and Member Contributions
An LLC operating agreement should also specify each owner’s contributions, as well as how profits are shared and distributed between members.
Contributions may differ by each member, and they may include capital, skills, labor, physical and intellectual property, and other valuable resources for your organization. In general, these contributions should be proportional to ownership interest in the LLC.
With an operating agreement, you have the flexibility to determine how to share and distribute profits and losses within the LLC. For example, they can be allocated in direct proportion to members’ ownership percentage (e.g., if you own 50% of the company, you share 50% of its profits and losses. This allocation is the most suitable for LLCs where owners have made similar contributions to the company.
However, you could also grant a special allocation to those members who have made significant contributions to the company in its early stages. This could provide them with a higher profit share than their ownership interest.
6. Additional Provisions
Including additional provisions in your LLC’s operating agreement is a sound strategy to outline how the business should deal with various (planned or unplanned) events or scenarios. These may include:
- LLC ownership transfer, which is covered in a transfer of business ownership agreement
- Member disputes
- The death or divorce of a member
- Future LLC operating agreement amendments
- A severability provision, which is included to ensure that the rest of the contract remains in full force and effect even if a part of the agreement becomes unenforceable or contradicts laws and regulations
- The dissolution of the business
By outlining pre-agreed processes to follow, the inclusion of additional provisions in the operating agreement ensures the stable operation of the LLC.
How to Write an Operating Agreement for Your LLC
To save on business expenses, you may decide to create an LLC operating agreement by yourself or use an online template for the draft. However, since it’s an absolutely critical document, we advise against drafting it without professional assistance, as it could have long-term ramifications for your company.
With Gordon Law‘s seasoned team of contract lawyers, you can create a clear and well-drafted operating agreement for your LLC. We leverage over 10 years of experience in fast and thorough contract representation and a unique blend of tax and business law to protect your company’s interests, prevent disputes, and ensure compliance with state and federal regulations.
With meticulous attention to detail and focused industry knowledge in sectors like ecommerce, marketing, esports, crypto, and more, we always aim to maximize your profits and provide strong legal protection for your LLC. If anything comes up on your side, feel free to contact our team with confidence at any time.
Schedule a consultation with one of our experienced contract lawyers at Gordon Law to establish the legal foundation for your LLC and protect yourself from liability for business debts!
Frequently Asked Questions (FAQ)
How to amend an LLC operating agreement?
After a while, you or other members may decide to amend the LLC operating agreement to reflect changes in your business. These may range from shifts in management structure (from member-managed to manager-managed and vice versa) to updated company information and changing capital contributions.
To amend an LLC operating agreement, you should propose the changes and discuss them with other members to gain their approval. Once you have the necessary votes, you may proceed with drafting the amendment with a legal professional (like Gordon Law’s team of experienced contract attorneys), and sign the amended contract along with all the other owners of the limited liability company.
Does a single-member LLC need an operating agreement?
An operating agreement plays the most critical role in multi-member LLCs. It helps resolve disputes, as well as define roles, responsibilities, ownership structure, and other important matters between owners.
But drafting an operating agreement is also advised even if you run a single-member LLC. Doing so allows you to set your own rules for your company’s day-to-day operations, ensures that you are not personally liable for business debts, and provides clarity. Having an LLC operating agreement may also be necessary for opening business bank accounts, raising investments, or striking deals with new partners.
Does an operating agreement need to be notarized in the case of an LLC?
In general, neither state nor federal laws require you to notarize LLC operating agreements for them to be legally valid. Unlike articles of incorporation and certificates of formation, you don’t have to file them with the state either.
That said, notarizing your LLC operating agreement could provide you with an extra layer of authenticity and help you prevent future disputes, especially if the contract’s validity is questioned.
Is there an LLC operating agreement template I can use to draft the contract?
Due to the importance of the document, we advise you against using an LLC operating agreement template or sample to draft the contract.
Instead, you should consult a team of seasoned contract lawyers—like the team at Gordon Law—who’ll help you create a well-drafted, clear, compliant, and legally binding operating agreement for your LLC.
