What Is it?
An operating agreement is a legal document that outlines the ownership and operating procedures of a Limited Liability Company (LLC). It typically includes information about the LLC’s management structure, members’ rights and responsibilities, voting procedures, profit and loss distribution, and other essential details.
Do You Need It?
In general, it is highly recommended that LLC owners create an operating agreement, even though it is not always legally required. This is because an operating agreement can help clarify the roles and expectations of LLC members, minimize potential disputes, and provide a legal framework for your business.
The Reasons Why
Without an operating agreement, state law will govern the operations of the LLC, and in some cases, this default framework may not align with your intentions or needs. No owner likes to be told how to run their business. Therefore, creating an operating agreement that reflects your company’s needs and goals is highly advisable. Here we listed a few reasons you should consider creating an operating agreement.
- Clarify the roles and responsibilities of members: Your operating agreement should outline the specific roles and responsibilities of each member of the LLC. This helps to minimize confusion and potential disputes in the future.
- Establish a management structure: The agreement can specify the management structure of the LLC, including who will be responsible for making major decisions, how decisions will be made, and how the LLC will be managed on a day-to-day basis.
- Customize financial and ownership arrangements: You can customize financial and ownership arrangements, such as profit and loss distribution, how much each member has invested, and how much each member is entitled to receive in distributions.
- Comply with state law: While an operating agreement is not always legally required, some states may require an LLC to have an operating agreement in place. Even if it is not required, it is always a good idea to have one to avoid any potential legal issues down the road.
- Protect personal liability: An operating agreement specifies that the LLC is a separate legal entity and that members are not personally liable for the LLC’s debts and obligations.
What Should You Include In Your Operating Agreement
An operating agreement typically includes the following information:
- Business information: The legal name of the LLC, its business purpose, the address of the principal place of business, and the names and addresses of the members.
- Ownership and management: The LLC's ownership percentages and management structure. This includes the number of members, whether the LLC is member-managed or manager-managed, and the managers' and members' powers and responsibilities.
- Capital contributions: The amount of capital each member contributes to the LLC and the ownership percentages of each member based on their contribution.
- Distributions: How profits and losses will be allocated among members and how distributions will be made to members.
- Voting rights: The voting rights of each member, including how votes will be cast and what percentage of votes are needed to approve an action.
- Buyout and transfer of membership: How a member can withdraw from the LLC or sell their membership interest, as well as the process for buying out members.
- Dissolution: The process of dissolving the LLC, including how the assets will be distributed and how creditors will be paid.
- Amendments: How the operating agreement can be amended, including the process of proposing and approving changes.
Can You Write It?
Just because you can, doesn’t mean you should. An operating agreement for an LLC should ideally be drafted by an attorney or a legal professional with experience in business law. This is because it is a legal document with significant implications for the LLC and its members. A poorly drafted operating agreement may leave gaps or ambiguity that could lead to disputes or legal liability. Therefore, it is advisable that you seek legal guidance in creating an operating agreement.
It is also important that you involve all members of the LLC in the process to ensure that everyone’s needs and concerns are addressed. By involving all members, you can prevent misunderstandings and disputes down the line and ensure that the operating agreement reflects the expectations of all members.