An operating agreement is imperative when forming an LLC and is basically the backbone of your LLC. Although most states don’t require an Operating Agreement when you set up your LLC it can still be a good idea to create one for internal purposes, to set operational guidelines and boundaries, and avoid any misunderstandings between members and a host of other reasons we will go into shortly. We will also explain what an Operating Agreement for an LLC is as well as the sections that are included in the document. For a more in-depth guide on the benefits of having an operating agreement and how you can get your own free custom operating agreement template just visit the TRUiC website.
What is an LLC Operating Agreement?
An operating agreement is basically the foundational document of your LLC that establishes ownership, outlines the rules of your business and clarifies the duties and responsibilities of your LLC’s members.
For both single member and multiple member LLC’s an operating agreement is beneficial as this document can strengthen the corporate veil and enhance your business’s credibility. Additionally in the case of the multiple member LLC an operating agreement can help avoid misunderstandings between members as a set of ground rules for the LLC will be in place protecting everyone’s interests.
What goes into an LLC Operating Agreement?
There are six important sections / articles to consider when creating an Operating Agreement:
In this preliminary section the basic information of the business is stated such as the name of the business, in which state it was formed, when it was formed, the number of members, who the members are and what percentage of ownership each member has.
- Management and Voting
In this section the following subjects will be covered: whether the LLC will be Member managed or Manager managed, how voting in the LLC will be carried out and what they will be voting on. Also this section will define how votes are allocated, i.e will there be one vote per person, will some members have more authority than others depending on the percentage of ownership they have etc.
- Capital Contributions
This section addresses which members have made money contributions to the LLC and explain how additional money can be raised by the members.
This article explains how the company’s profits and losses are distributed among the members. This might pertain to how money is distributed, physical assets or other business assets.
- Membership Changes
This section describes what the process is for adding or removing members as well as if and when members can transfer their ownership of the business and what happens when a member dies.
This article explains when the business may or must be dissolved. If the company has assets this section might also describe how these assets will be distributed when the company is dissolved.
Some operating agreements also have other sections or might differ slightly but this is the main structure of an LLC operating agreement. There might be sections explaining how to make changes and amendments to the operating agreement or what type of tax election your LLC will choose i.e how the LLC will be taxed as a sole proprietorship, partnership, S Corp or C Corp. Depending on your LLC’s unique needs and priorities you should make your own custom operating agreement to help you better define your business and keep yourself protected.
After creating your operating agreement you can change and make any amendments you might need as long as all LLC members agree with these changes. This is a legal document and you don’t need to file your operating agreement with the Secretary of State but you need to check if your state legally requires your LLC to have an operating agreement. It is also advisable to keep copies of your operating agreement and give your business members their own copies.