An LLC operating agreement is a legal document that governs the operations of an LLC.
An LLC, or Limited Liability Company, is a business structure that offers its owners some advantages of both, a corporation and a partnership.
Like shareholders in a corporation, LLC owners are not personally liable for the debts and other liabilities incurred by the business. But unlike shareholders, they don’t face double-taxation. Instead, those profits “pass-through” the business, and the owners’ pay on their personal tax returns. In addition, an LLC can be owned by one person or multiple people.
LLCs also offer greater flexibility than Corporations in how they are governed. Corporations have to hold annual meetings, elect a Board of Directors, and record meeting minutes (notes). On the other hand, an LLC is much more flexible when it comes to management. And there are no annual meeting requirements, no Board of Directors, and no need to record meeting minutes. LLCs are governed by a document called the LLC Operating Agreement.
Why Might You Need an Operating Agreement?
An operating agreement for an LLC is not required in all states, but it is highly recommended. An operating agreement sets forth the rules and regulations for how your LLC will be governed and operated. It spells out the rights and responsibilities of your LLC members (or owners) and provides a clear plan for what will happen if there are disagreements among the members or if someone wants to leave the LLC.
If you don’t have an operating agreement, your LLC will be governed by the default rules outlined in your state’s LLC statutes. These default rules may not be ideal for your business, so it’s always best to have an operating agreement. An LLC operating agreement can help you do the following:
Show that your LLC is a separate business entity
If your LLC ever faces legal challenges, you can use an operating agreement to show that it is a legitimate business with valid governance rules. This is especially important if your LLC has just one owner. Some courts may be more likely to “pierce the corporate veil” and hold the owner personally liable for the LLC’s debts and other liabilities without an operating agreement.
Resolve disagreements among owners
An operating agreement can help prevent misunderstandings by spelling out everyone’s roles and expectations. It can also provide a process for resolving disagreements so that owners don’t have to go to court whenever they disagree.
Protect your assets
By creating an LLC, you can shield your personal assets in the event your business faces a lawsuit. “Having an LLC Operating Agreement can help keep this liability protection in place.”
Information that is included in the LLC Operating Agreement
Operating Agreements can be simple or complex, depending on the size and needs of your LLC. But regardless of the length or complexity, all operating agreements should address the following topics:
1. Percentages of ownership interest
2. Voting rights
3. Profit and loss distribution
4. Member duties and responsibilities
5. Manager duties and responsibilities (if applicable)
6. Admission of new members
7. Removal of members
8. Dissolution of the LLC
Now let’s take a closer look at each topic that should be covered in an operating agreement for an LLC.
1. Percentages of ownership interest
The first thing you’ll need to do is determine the percentage of ownership interest that each member will have in the LLC. This can be equal or unequal, depending on the circumstances. For example, if you are the only member of your LLC, you’ll have a 100% ownership interest.
If there are two members, each can have a 50% ownership interest. Or, one member can have a 60% ownership interest, and the other can have a 40% interest.
It’s important to note that the percentage of ownership interest should be proportionate to the amount of initial capital each LLC Member (owner) contributes to the LLC. For example, if an LLC has 2 Members and each owns 50%, then they should both make an initial capital contribution of $500 each, or $5,000 each, for example. Or if one person owns 20% of the person (and their initial capital contribution is $2,000), then the 2nd person who owns 80% of the business should make an initial capital contribution of $8,000.
2. Voting rights
The second most important issue you should address in your operating agreement is voting rights. Voting rights give members a say in how the LLC is governed and operated. For example, voting rights can be used to elect the members of the LLC’s governing body, make decisions about major changes to the business, and approve the admission of new members.
Voting rights can be either equal or unequal, depending on the needs of the LLC.
3. Profit and loss distribution
The third point you should address in your operating agreement is how profits and losses will be distributed among the members. This is an essential issue because it will determine the share of the profits that each member will receive if the LLC is profitable and how much each member will pay if the LLC incurs losses.
There are two main ways to distribute profits and losses: equally and disproportionately.
With an equal distribution, each member will receive the same percentage of the profits or losses regardless of the percentage of ownership interest. With a disproportionate distribution, each member’s percentage of profits or losses will be based on their percentage of ownership interest.
The important thing is to clearly define how profits and losses will be distributed among the members in your operating agreement. Having said that, typically, LLC profits (called distributions) are proportionate to the LLC ownership percentages.
4. Member management
Another important piece of information that should be addressed in your operating agreement is member management. This is an important issue because it will determine who will have the authority to decide about the LLC.
There are a few different options when it comes to member management.
- The first is that each member can have an equal say in the direction of the LLC. This means that all members will need to agree on any decisions made about the business.
- The second option is to give one member the authority to make decisions on behalf of the LLC. This member is typically the LLC’s manager.
- The third option is to have a board of directors who will make decisions about the business.
No matter which management structure you choose, it is important to have it laid out in your operating agreement.
Admission of new members
The procedure for the admission of new members should also be addressed in your operating agreement. This is an important issue because it will determine how new members can join the LLC.
The two main ways to admit new members are – voting by the existing members or through unanimous consent. There are pros and cons to both methods. Voting by existing members gives the LLC more control over who joins, but it can also be difficult to get everyone to agree on a new member. Unanimous consent is easier to achieve, but any member can veto a new member.
Changes to the LLC
Another issue to be addressed in your operating agreement is how you can make changes to the LLC. This is an important issue because it will determine how the LLC can be changed.
The LLC operating agreement is a contract between the LLC members that outlines how the LLC will be managed and operated. The operating agreement should include information about the LLC’s purpose, ownership, management, and member roles and responsibilities.
Keeping your operating agreement up-to-date is important as your business grows and changes. You may need to change the LLC information included in your agreement, such as the LLC’s name, registered address, or principal place of business.
Dissolution of the LLC
Another crucial thing you should address in your operating agreement is the dissolution of the LLC. The LLC may be dissolved voluntarily or involuntarily. The members of the LLC can vote to dissolve the company voluntarily, while an involuntary dissolution can occur when a court orders the dissolution of the LLC.
How to Create an Operating Agreement?
To create an operating agreement for your LLC, you’ll need to make sure you understand your state’s requirements. For example, if you are considering starting an LLC in Florida, the rules of the state of Florida regarding LLCs will apply. This is because some states have specific requirements for what must be included in an operating agreement. Once you have all the required information, you can create your agreement.
- The first step in creating an Operating Agreement is determining the LLC’s business purpose. This can be as simple as “engaging in business activities for profit.” Once the business purpose is determined, the next step is identifying the LLC members and their roles within the company.
- The Operating Agreement’s next section should outline each LLC member’s ownership percentage. This will determine each member’s share of profits and losses and their rights and responsibilities within the company.
- The final section of the Operating Agreement should detail the LLC’s operating procedures. This includes how decisions will be made, how members can be replaced, and what happens if the LLC is dissolved.
You should also be aware that an operating agreement is a contract, so an attorney should review it before it is signed. This is especially important if your LLC has more than one owner, as there may be tax and liability implications that need to be considered. Once the operating agreement is finalized, all of the LLC’s owners should sign it. Keeping a copy of the agreement in the LLC’s corporate records is also a good idea.
An LLC operating agreement is a legal document that governs the operations of an LLC. The operating agreement should address important issues such as the management structure of the LLC, admission of new members, changes to the LLC, and dissolution of the LLC.
It’s important to consult with an attorney to ensure that your operating agreement is complete and covers all important issues. Your attorney can help you determine what needs to be included in your operating agreement and help you draft the agreement. Contact a qualified business attorney today to get started.