Operating Agreement 101: A Key To A Successful LLC
By Bazal Razzaq
Chief Editor
Updated: July 10, 2023
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Whether starting a Limited Liability Company(LLC) or thinking of formalizing and structuring your existing business, it’s important to know and understand an operating agreement.
However, chances are you were already seeking an overview of the document. If it is true, continue reading, you won’t be disappointed!
What is an Operating Agreement? Why Do You Need One?
It is an internal document that contains information on the LLC’s working terms and describes its members’ roles, rights, and responsibilities. While this may not be necessary for all US states, you should consider creating one if the co-owners/members disagree and need help arriving at a solution.
This document explains how a company will be managed, controlled, and taken care of and how the owners/members will work together. You can think of it as a rulebook for your business, where the rules are to be followed by the owners/members.
It contains important information like how to arrive at a decision, how to share profits and losses, and who owns how many shares of the LLC. The agreement helps entrepreneurs avoid fights between the owners/members and gives everyone a clear understanding of their rights, roles, and responsibilities.
The documents also include details on how the LLC will hold meetings. It explains when and where the meetings will take place and how to make decisions during that meeting. We understand what you’re wondering: why is it even important? The document sets clear guidelines for communication and decision-making among the members.
Not just this, a well-drafted agreement also acts as a legal shield for the company.
Yes! One agreement, multiple solutions! You definitely need one, as it helps members work together more effectively, reduces fights and misunderstandings, and ensures that your LLC works smoothly.
What To Include In An LLC Operating Agreement?
Even though the agreement should cover multiple issues, here’s a general document format. It should include the following:
- Basic LLC Information: You can begin with basic information about your LLC, like its formal name, why is it formed, principal place of business, management structure, information about the registered agent, and other such basic details that are important to forming an LLC.
- Ownership Percentage of Owners/Members: You need to mention the names and addresses of the LLC owners/members. These members usually contribute to the business, like cash, services, property, and legal efforts, to form their LLC from scratch.
And accordingly, get an ownership percentage according to the capital they raised during the start. However, no “rule” says that’s exactly how you should do it.
The owners/members of the LLC can decide the ownership in any percentage and way they want. But, to avoid future fights or confusion, you should mention the ownership shares in the agreement.
- Voting Rights and Responsibilities: The document should also contain a set process for voting on major or minor decisions. The agreement should clearly outline whether each owner gets one vote or whether their voting power depends on ownership percentages.
- Powers and Tasks of Members and Managers: The agreement should clearly describe whether the LLC will be member-managed or manager-managed. If it’s manager-managed, highlight the individuals who will serve as managers and specify their roles and responsibilities. And if it’s member-managed, mention how much power and duties each member gets.
- Sharing Profits and Losses: Clearly outline how the profits and losses will be dispersed among the members yearly. This is probably the most useful section of your agreement since handling losses, distributions of profits, returns, or special allocations will ultimately come down to this.
- Taxation: An ideal agreement should also explain issues related to taxes:
- Who will file taxes?
- Will any losses that occur without the active involvement of the members affect the amount of money they have invested in the LLC?
- Will the LLC be taxed like a C-corporation or as a pass-through entity?
- If the owners/members invest money in the LLC, will they be responsible for paying income taxes in the state where the LLC is registered?
- Business Operations: Important LLC activities like holding meetings, saying yes to decisions taken by the manager, and adding or removing members come with different procedures and tantrums. You can care for them by planning and addressing them in your agreement.
- Dissolution or termination: Under this section, you need to mention the situations under which the LLC can be dissolved, such as a collective vote, or due to certain events. You need to explain the process of shutting down the LLC and dividing its assets after dissolution.
- Special provisions and amendments to the agreement: Set a clear process for updating or making changes to the current agreement and whether the decision would rest on collective voting of all owners/members or even a majority vote.
Other than that, you can mention any additional precautions on what should happen in case of unplanned events, like an owner’s death, fights between the members, or a member’s sudden withdrawal.
In many cases, the agreements close with a “severability provision,” which means the rest of the agreement will still be followed even if one part proves contrary to state or federal laws or is otherwise invalid.
Benefits of An Operating Agreement
The document offers a lot of benefits for your Limited Liability Company(LLC), such as:
- It Provides Personal Liability Protection: By creating an agreement in place, your LLC can maintain the limited liability protection it provides. Unclear? It means that if your LLC is functioning properly, the members’ assets will remain protected from the debts and liabilities of the business.
- It Helps Understand Ownership and Structure: Probably the biggest benefit of the agreement is that it clearly highlights the ownership interests of the owners/members, the money they invested, and the basic structure of the LLC. It helps understand each member’s roles, rights, and responsibilities within the company.
- It Helps Prevents And Solves Future Fights: Yes, the most obvious. The agreement outlines the rights, roles, obligations, and decision-making of every owner/member involved. As a result, it creates an existing solution for future fights, misunderstandings, and confusion between the members.
- It Provides Legal Documentation: Your agreement also serves as a legal document that displays the existence and legitimacy of your LLC. It can especially be important when dealing with banks, investors, and government agencies, as it helps provide proof of the company’s agreements and activities.
- It Helps With Financial Decisions: Having an agreement for your LLC helps with financial transactions. Lenders, investors, or potential buyers may need or request a copy of the document to understand the company’s structure, management, and ownership.
- It Offers Future Guidance: The document can include guidelines for different situations, such as adding or removing members or buyout shares. It provides guidelines for future events for smooth decision-making.
Basic Provisions
Some basic provisions generally found in an agreement are:
- Name and address of the LLC: The document should contain the name and address of your LLC’s business and registered office.
- Statement of Intent: It confirms that your agreement follows the state laws, and after the filling of the necessary documents, it becomes active.
- Purpose of your LLC: It explains what your LLC is and what kind of business it involves. It can also include any future changes in the business.
- Term: This section contains information on how long the LLC will run until it closes down or gets terminated according to state laws.
- New Members/Owners: The document should have clear instructions on adding or removing members/owners. In case there’s a new entry, there should be a mention of the process for the new member to get ownership interest in the business.
- Tax Treatment: It explains how the LLC will pay taxes as a sole proprietorship, partnership, or corporation.
Some other provisions that businesses include in their agreements are,
- Names, titles, addresses, contact details, and ownership interests of all members and managers(if any).
- Each member puts forward The capital value during the start of your LLC.
- Any additional contributions required by any owners/members.
- Information on when the meetings will be held and any rules to be taken care of during those meetings.
- The conditions and process for dissolution of the LLC.
Final Word
Throughout the blog, you may have realized that creating an operating agreement for your LLC has only positives and no negatives. It offers genuine help to running your business. Even though it’s legally binding, you change or alter it at any time. If and when your business grows and changes, you can make the necessary changes to meet the company’s and its members’ needs.
In summary, it is a legal formality and a handy tool that sets a strong foundation for your LLC’s functioning.
It promotes transparency, clarity, and fairness among members and greatly affects the company’s long-term success. By investing time and attention into creating a well-crafted agreement, an LLC can set itself up for growth, stability, and fruitful collaboration among its members.
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Frequently Asked Questions (FAQs)
Maine, New York, California, Missouri, and Delaware are mandatory states to have an agreement. Even though it isn’t a requirement in every state, we suggest you create one.
You can write your agreement for your limited liability company (LLC). Since it consists of the functions and activities of your own company, the rules and conditions mentioned in an agreement could be personal to all members. In that case, whether or not to hire a lawyer completely depends on the owners/members of your LLC.
In most cases, you don’t need to file the agreement with the state. The agreement t is an internal document for the LLC and is not typically required to be filed with government authorities.
However, we suggest keeping a copy of the agreement with your LLC’s records for future reference and problems.