What is an LLC Operating Agreement & How to Make One

Among the different types of businesses that you can establish, LLCs, which are also known as Limited Liability Companies hold a prominent place. Most of the founders prefer an LLC because of the flexibility and convenience that comes along with it.

When you’re forming an LLC, there are many documents that need to be prepared – one of which is the LLC operating agreement. Keep on reading this article and we will share all details that you need to know about it.

What exactly is an LLC operating agreement?

The LLC operating agreement defines the structure and rules that a Limited liability Company should follow. It addresses all the issues that may arise now and in the future during the normal course of business, in the case of disputes, or any other type of situation.

In most states, there are default provisions of an LLC. You’re free to add provisions and regulations to your LLC operating agreement that are peculiar to your business. However, the terms stated in the LLC operating agreement can override all those default provisions.

Hence, the LLC operating agreement can be considered as a specific document that is related to a company and its progression. Once the LLC operating agreement is finalized and signed, it’s considered the binding contract that exists between all the members of the limited liability company.

Whenever a member encounters a challenging situation, it is possible to take a look at the LLC operating agreement and determine the protocols that should be followed. That’s because it acts in the form of a centralized reference point.

An LLC operating agreement would usually include numerous factors that are related to the governance of a company. They include:

  • Member investments
  • Management structure
  • Number of members
  • Tax considerations
  • Profit-sharing methodology

After creating the LLC operating agreement, you don’t need to file it with the state. Think of it as an internal legal document whereas the articles of organization are filed with the state authorities.

In fact, the articles of organization are documents that are available to the public. However, the LLC operating agreement is not a publicly available document and it is defined only for the members of the LLC.

How to draft an LLC operating agreement?

There are multiple steps that need to be followed at the time of drafting an LLC operating agreement. Keep in mind that this document will determine how your business functions so it’s important to take the time to get it right.

Basic/introductory information to include in the LLC operating agreement

As the very first step of drafting an LLC operating agreement, you should take a look at the basic provisions to include. They’re mentioned below and should be included at the bare minimum.  Of course, there are additional provisions that should be added which we’ll touch on in the next section.

  • Identifying information

All information that can be used to identify the LLC should be included in the LLC operating agreement. They include the name of the LLC, the address of the principal business office, and the address of the registered office.

  • Statement of intent

The statement of intent is an agreement that defines that the LLC adheres to all relevant regulations. Moreover, it includes that the LLC would only come into existence after the official documents are completed.

  • Purpose of business

A statement that highlights the purpose of the LLC is included as well. This would contain information related to the nature of the business and the products or services offered by it.  

  • Term

The term or duration of the LLC is specified in the LLC operating agreement. It is possible for the business to operate until it is terminated according to how it is defined in the LLC operating agreement or to proceed until dissolved.

  • Tax treatment

The LLC operating agreement defines whether the LLC would be taxed based on partnership, sole proprietorship, or as a corporation.

  • Admission of new members

Whether an LLC is started alone or with a group of partners, it is important to include a section that defines how the admission of new members to the LLC would be treated. This can prevent disputes in the future and allow for seamless admission or expulsion of members.

Core provisions to be included in the LLC operating agreement

The basic provisions are considered to be an introduction to the LLC operating agreement. The main provisions that define how the business works are below.

  • Capital contributions

The LLC operating agreement can include details related to the capital contributions that each member of the LLC made. Keep in mind that it’s up to you to define what a capital contribution is and oftentimes it can be in the form of something besides cash like services or property.

  • Identification of managers and members

All details of the managers and members of the LLC are included in the LLC operating agreement. This includes their names, titles, and addresses. While this information is considered optional in certain jurisdictions, it’ll help uphold the limited liability nature of the organization – especially in court.

  • Additional capital contributions

There are situations where the businesses will come across the need to raise additional capital. In such situations, the additional capital contributions would be included in the LLC operating agreement.

If there are additional contributions made by the member, the percentage of interest that member would have in the business would change. How it would happen is defined in LLC operating agreement.

  • Distribution of profits and losses

Based on the contribution made by the members, profits and losses vary. This will be defined in the LLC operating agreement as well. In general, each member is allocated a percentage or share of the profits which corresponds to the percentage of interest the member has in the business.

When it comes to an LLC, the profit is usually passed on to an individual unless they’ve specifically set up the company so it functions like a corporation. If it’s an individual pass-through then the members are taxed at an individual level.

The LLC operating agreement will also contain details on how losses are distributed. This is one of the biggest considerations when creating your LLC operating agreement.

  • Member meetings and the voting procedure

The LLC operating agreement will contain information related to the member meetings. It includes the meeting rules, how member meetings will be held, and where votes will take place.

On the other hand, the LLC operating agreement will contain information on how many members should be present for a quorum to be reached and how the voting process will proceed.

According to this agreement, it’s determined whether each member will have one vote, or if voting power is determined by the percentage of interest that he/she holds in the LLC. Even information on whether a unanimous vote or a majority vote is required will be included in the LLC operating agreement.

When an LLC is has a large number of members, the rules related to a quorum can be adjusted so that the LLC can still make decisions quickly. For example, with a 50 member LLC, you may only require 20 people to be present to make binding decisions.

  • Management structure

The management structure of the LLC is clearly defined according to the LLC operating agreement. If the LLC is managed by the owners, specific details with related to them such as the way managers will be elected/appointed are included. It also contains information related to their salaries.

It may not be the exact salary but it’ll share salary ranges to aim for. On the other hand, the LLC operating agreement will have information on the duration they will serve and whether there are any limitations related to the authority of the managers.

  • Admission and withdrawal of members

The LLC operating agreement offers details related to the admission as well as withdrawal of members. It also contains details on what would happen when a member is looking forward to withdrawing from the position.

  • Duties and compensation of members

It is possible to clearly define the duties of each member of the LLC, which is required for managing the overall operations of the LLC. Moreover, the LLC operating agreement will have information on whether the members will receive additional compensation based on the specific duties that they do within the LLC.

  • Transfer of interest

In the LLC operating agreement, you can define the way the interest of a member can be transferred. In the operating agreements, there is a clause that defines the right of first refusal when a member is willing to sell the rights to the other members. Moreover, this would indicate information on what would happen when a third party purchases that interest from a departing member.

  • Death of the member

In the LLC operating agreement, the way the interest of a member would be managed after the death of that member is defined. This would have common provisions, where the remaining members will be able to purchase that interest or provide the opportunity for a relative of the deceased member to obtain the interest.

It is even possible to define a provision to transfer the interest. However, the transferee will only be able to gain rights to the profits. In other words, the transferee will not be able to actively take part in the business decisions that are being made.

This can protect other members from having to follow the whims of someone that doesn’t understand the business.

  • Dissolution

All the terms and procedures related to rounding up the LLC are clearly defined. Does it need a unanimous vote, will it happen after certain types of litigation, or is it time-bound?  How does the LLC handle the distribution of the remaining assets, etc.?

Final word on LLC operating agreement

Now you have a basic understanding of the provisions that should be included in an LLC operating agreement. These are the most prominent provisions in the agreement but it doesn’t cover every possible provision.

Depending on the complexity of the LLC, you may need to add more provisions to protect your interests. For example, there are numerous tax, legal, and practical considerations that would come into effect along with the LLC operating agreement.

If you’re looking for how to form your LLC, be sure to check out our guides and some of the services that you can use to make this process much easier.

Among the different types of businesses that you can establish, LLCs, which are also known as Limited Liability Companies hold a prominent place. Most of the founders prefer an LLC because of the flexibility and convenience that comes along with it.

When you’re forming an LLC, there are many documents that need to be prepared – one of which is the LLC operating agreement. Keep on reading this article and we will share all details that you need to know about it.

What exactly is an LLC operating agreement?

The LLC operating agreement defines the structure and rules that a Limited liability Company should follow. It addresses all the issues that may arise now and in the future during the normal course of business, in the case of disputes, or any other type of situation.

In most states, there are default provisions of an LLC. You’re free to add provisions and regulations to your LLC operating agreement that are peculiar to your business. However, the terms stated in the LLC operating agreement can override all those default provisions.

Hence, the LLC operating agreement can be considered as a specific document that is related to a company and its progression. Once the LLC operating agreement is finalized and signed, it’s considered the binding contract that exists between all the members of the limited liability company.

Whenever a member encounters a challenging situation, it is possible to take a look at the LLC operating agreement and determine the protocols that should be followed. That’s because it acts in the form of a centralized reference point.

An LLC operating agreement would usually include numerous factors that are related to the governance of a company. They include:

  • Member investments
  • Management structure
  • Number of members
  • Tax considerations
  • Profit-sharing methodology

After creating the LLC operating agreement, you don’t need to file it with the state. Think of it as an internal legal document whereas the articles of organization are filed with the state authorities.

In fact, the articles of organization are documents that are available to the public. However, the LLC operating agreement is not a publicly available document and it is defined only for the members of the LLC.

How to draft an LLC operating agreement?

There are multiple steps that need to be followed at the time of drafting an LLC operating agreement. Keep in mind that this document will determine how your business functions so it’s important to take the time to get it right.

Basic/introductory information to include in the LLC operating agreement

As the very first step of drafting an LLC operating agreement, you should take a look at the basic provisions to include. They’re mentioned below and should be included at the bare minimum.  Of course, there are additional provisions that should be added which we’ll touch on in the next section.

  • Identifying information

All information that can be used to identify the LLC should be included in the LLC operating agreement. They include the name of the LLC, the address of the principal business office, and the address of the registered office.

  • Statement of intent

The statement of intent is an agreement that defines that the LLC adheres to all relevant regulations. Moreover, it includes that the LLC would only come into existence after the official documents are completed.

  • Purpose of business

A statement that highlights the purpose of the LLC is included as well. This would contain information related to the nature of the business and the products or services offered by it.  

  • Term

The term or duration of the LLC is specified in the LLC operating agreement. It is possible for the business to operate until it is terminated according to how it is defined in the LLC operating agreement or to proceed until dissolved.

  • Tax treatment

The LLC operating agreement defines whether the LLC would be taxed based on partnership, sole proprietorship, or as a corporation.

  • Admission of new members

Whether an LLC is started alone or with a group of partners, it is important to include a section that defines how the admission of new members to the LLC would be treated. This can prevent disputes in the future and allow for seamless admission or expulsion of members.

Core provisions to be included in the LLC operating agreement

The basic provisions are considered to be an introduction to the LLC operating agreement. The main provisions that define how the business works are below.

  • Capital contributions

The LLC operating agreement can include details related to the capital contributions that each member of the LLC made. Keep in mind that it’s up to you to define what a capital contribution is and oftentimes it can be in the form of something besides cash like services or property.

  • Identification of managers and members

All details of the managers and members of the LLC are included in the LLC operating agreement. This includes their names, titles, and addresses. While this information is considered optional in certain jurisdictions, it’ll help uphold the limited liability nature of the organization – especially in court.

  • Additional capital contributions

There are situations where the businesses will come across the need to raise additional capital. In such situations, the additional capital contributions would be included in the LLC operating agreement.

If there are additional contributions made by the member, the percentage of interest that member would have in the business would change. How it would happen is defined in LLC operating agreement.

  • Distribution of profits and losses

Based on the contribution made by the members, profits and losses vary. This will be defined in the LLC operating agreement as well. In general, each member is allocated a percentage or share of the profits which corresponds to the percentage of interest the member has in the business.

When it comes to an LLC, the profit is usually passed on to an individual unless they’ve specifically set up the company so it functions like a corporation. If it’s an individual pass-through then the members are taxed at an individual level.

The LLC operating agreement will also contain details on how losses are distributed. This is one of the biggest considerations when creating your LLC operating agreement.

  • Member meetings and the voting procedure

The LLC operating agreement will contain information related to the member meetings. It includes the meeting rules, how member meetings will be held, and where votes will take place.

On the other hand, the LLC operating agreement will contain information on how many members should be present for a quorum to be reached and how the voting process will proceed.

According to this agreement, it’s determined whether each member will have one vote, or if voting power is determined by the percentage of interest that he/she holds in the LLC. Even information on whether a unanimous vote or a majority vote is required will be included in the LLC operating agreement.

When an LLC is has a large number of members, the rules related to a quorum can be adjusted so that the LLC can still make decisions quickly. For example, with a 50 member LLC, you may only require 20 people to be present to make binding decisions.

  • Management structure

The management structure of the LLC is clearly defined according to the LLC operating agreement. If the LLC is managed by the owners, specific details with related to them such as the way managers will be elected/appointed are included. It also contains information related to their salaries.

It may not be the exact salary but it’ll share salary ranges to aim for. On the other hand, the LLC operating agreement will have information on the duration they will serve and whether there are any limitations related to the authority of the managers.

  • Admission and withdrawal of members

The LLC operating agreement offers details related to the admission as well as withdrawal of members. It also contains details on what would happen when a member is looking forward to withdrawing from the position.

  • Duties and compensation of members

It is possible to clearly define the duties of each member of the LLC, which is required for managing the overall operations of the LLC. Moreover, the LLC operating agreement will have information on whether the members will receive additional compensation based on the specific duties that they do within the LLC.

  • Transfer of interest

In the LLC operating agreement, you can define the way the interest of a member can be transferred. In the operating agreements, there is a clause that defines the right of first refusal when a member is willing to sell the rights to the other members. Moreover, this would indicate information on what would happen when a third party purchases that interest from a departing member.

  • Death of the member

In the LLC operating agreement, the way the interest of a member would be managed after the death of that member is defined. This would have common provisions, where the remaining members will be able to purchase that interest or provide the opportunity for a relative of the deceased member to obtain the interest.

It is even possible to define a provision to transfer the interest. However, the transferee will only be able to gain rights to the profits. In other words, the transferee will not be able to actively take part in the business decisions that are being made.

This can protect other members from having to follow the whims of someone that doesn’t understand the business.

  • Dissolution

All the terms and procedures related to rounding up the LLC are clearly defined. Does it need a unanimous vote, will it happen after certain types of litigation, or is it time-bound?  How does the LLC handle the distribution of the remaining assets, etc.?

Final word on LLC operating agreement

Now you have a basic understanding of the provisions that should be included in an LLC operating agreement. These are the most prominent provisions in the agreement but it doesn’t cover every possible provision.

Depending on the complexity of the LLC, you may need to add more provisions to protect your interests. For example, there are numerous tax, legal, and practical considerations that would come into effect along with the LLC operating agreement.

If you’re looking for how to form your LLC, be sure to check out our guides and some of the services that you can use to make this process much easier.