An operating agreement governs the operation of a Limited Liability Company (LLC) in the same way that the bylaws of an incorporation govern the business decisions of a corporation. This legal document outlines the ownership rights and member duties of the owners of the Limited Liability Company.
What is the purpose of an operating agreement?
An operating agreement of an LLC outlines the key regulations, rules and provisions of the business. It is intended to govern the internal operations of the business. If there is more than one owner, or member, of a limited liability company, the operating agreement becomes a binding contract.
When is an operating agreement required?
An operating agreement is required in:
- California
- Delaware
- Maine
- Missouri
- Nebraska
- New York
Even if an operating agreement is not required by law, it might be important to have one. An operating agreement serves three major purposes:
- It gives the members of the Limited Liability Company control over their business. In the absence of an operating agreement, the state default rules will govern aspects of the company.
- It protects the members from personal liability. In the absence of an operating agreement, it might seem like they are running a sole proprietorship or partnership.
- In a multi-member LLC, the operating agreement minimizes disputes and misunderstanding between the members by outlining the terms of the arrangement in writing. When members agree to terms with an oral agreement, there is a higher likelihood that a dispute will take place. By having the business arrangements and operational conditions outlined in the operating agreement, members can refer to the written document when a conflict does arise.
What should be in an Operating Agreement?
All operating agreements are different. However, each agreement must contain the following six sections:
- Organization: The first section of the agreement is about the creation of the business. This section covers the company name, creation date, names of business members, ownership structure and location of the principal place of business. The members may own equal shares of the company or not.
- Management and voting: The second section of the agreement is about how the company is managed and how the members vote. The business may be managed by the members or by a manager appointed by the members. The agreement may outline numerous ways to allocate votes among the members of the company, including a single vote per member, single vote per unit of interest owned by the member, to name a few.
- Capital contributions: The third section of the agreement describes the capital contributions of each member to start the company. It also describes how the members will raise additional funds for the company.
- Distributions: The fourth section of the agreement outlines how the LLC members will share profits and losses, including business assets, money or other physical property.
- Membership changes: The fifth section of the agreement describes how members can be added or removed. It also covers when and how LLC members can transfer their ownership interest to another (e.g., when a member dies, when a member goes bankrupt, when two members get divorced).
- Dissolution: The sixth section of the agreement is about when the company may or must dissolve (known as “winding up” the company’s affairs).
Depending on the company’s circumstance, operating agreements address other topics in addition to the six required sections. Other common topics covered in operating agreements include the statement of intent, capital contributions, business purpose, the term during which the company will operate and how the company will be taxed.
Where is the Operating Agreement filed?
The Operating Agreement document is only between the members of the LLC. Even though there are a few states that require the creation of an operating agreement, no states require it to be filed.
Operating Agreement Template
It is highly recommended to have a legal professional review an LLC operating agreement in order to ensure the members are fully covered and the agreement complies with state laws. Sometimes this expense may not be in the budget when starting a business, so here are some LLC operating agreement templates.
