When forming an LLC, one of the most important documents you’ll need is an LLC operating agreement. This agreement sets the foundation for how your business will run and can help prevent conflicts down the road.

We at The Law Dictionary have broken down the process of developing an LLC operating agreement into easy-to-follow steps, so you can set up and manage your LLC with confidence.

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What Is An LLC Operating Agreement?

An LLC operating agreement is a contract between the members of an LLC that outlines the management and operation of the business. It serves as a roadmap for your company, covering everything from ownership percentages to decision-making processes. This document details the fundamentals of your business operations, including how profits and losses will be distributed, the procedure if a member decides to leave, and how the company will be managed on a day-to-day basis.

Does My LLC Need an Operating Agreement?

Yes, your LLC needs an operating agreement, even if your state doesn’t require one. While only five states (California, Delaware, Maine, Missouri, and New York) legally mandate operating agreements, having one is a smart move for every LLC. Without an agreement, your LLC will be subject to your state’s default LLC laws, which may not align with your business goals or the wishes of your members.

Let’s say you and your business partners have a verbal agreement about how to handle a member leaving the company. Without a written operating agreement, that verbal agreement won’t hold up if challenged. You’ll be stuck following state laws, which might allow a member to sell their share to anyone they choose – even if that’s not what you all originally intended.

How to Create an LLC Operating Agreement

Creating an LLC operating agreement doesn’t have to be complicated. We’ve broken it down into four main steps to help you craft a comprehensive document that covers all the bases.

Step 1: Determine Ownership and Profit/Loss Distribution

The first step in creating your operating agreement is to clearly define the ownership structure of your LLC, specifying who owns what percentage of the business. You’ll need to list each member’s name, address, and their ownership percentage. Typically, ownership percentages are based on the amount of money each member contributed to start the LLC. For example, if you contributed 60% of the startup costs, you’d likely have a 60% ownership stake.

Don’t forget to outline how profits and losses will be distributed. Will it be in proportion to ownership percentages, or will you use a different method? Be clear about this to avoid future disagreements.

Step 2: Establish Management Structure

Next, you’ll need to decide on your LLC’s management structure. You have two primary options: member-managed or manager-managed. In a member-managed LLC, all members are involved in the day-to-day operations of the business. This is common in smaller LLCs where all members are actively involved.

In a manager-managed LLC, you appoint one or more people (who may or may not be members) to handle daily operations. This structure can be useful if some members want to be passive investors or if you need specialized management expertise.

Your operating agreement should clearly state which structure you’ve chosen and outline the specific roles and responsibilities of managers or managing members.

Step 3: Assign Rights and Responsibilities

This section of your operating agreement is where you’ll get into the nitty-gritty of how your LLC will function. You’ll want to outline the rights and responsibilities of each member. This includes voting rights (do all members get an equal vote, or is it proportional to ownership?), roles within the company, and any specific duties assigned to each member.

If you’re opting for a member-managed structure, be sure to detail the daily responsibilities of each member. For manager-managed LLCs, clearly define the scope of the manager’s authority and how they’ll be held accountable to the members.

Step 4: Detail the Terms of Dissolution

While it may seem pessimistic to plan for your LLC’s end when you’re just starting out, it’s actually a smart business move. Your operating agreement should include a section on how the LLC will be dissolved if necessary. This includes outlining the conditions under which dissolution might occur (like if a key member leaves or if the business becomes unprofitable) and how assets will be distributed among members if the LLC is dissolved.

Including dissolution terms in your agreement can help prevent complications and confusion in the future. It ensures that if the worst happens, you have a clear, agreed-upon process to follow, rather than getting bogged down in disputes or defaulting to state laws that may not suit your situation.

The Value of Professional Guidance

While it’s possible to create an LLC operating agreement on your own, we strongly recommend seeking professional help. A lawyer or a reputable LLC formation service can provide invaluable assistance in crafting an agreement that’s tailored to your specific needs and compliant with your state’s laws. They can help you anticipate potential issues and include provisions that you might not have thought of on your own. The cost of professional help upfront can save you from costly legal battles or business disputes in the future.

FAQs:

Can I make my own operating agreement?

Yes, you can create your own operating agreement, but it’s often advisable to use a template or seek professional assistance to ensure all necessary points are covered.

How do I create a simple operating agreement for an LLC?

To create a simple operating agreement, focus on the basics: ownership structure, management roles, profit distribution, and dissolution terms. Use clear language and be specific about each point.

Do I need an operating agreement for a sole-owner LLC?

Even for single-member LLCs, an operating agreement is beneficial. It can help maintain your limited liability status and provide guidelines if you decide to add members later.

What states require LLCs to have operating agreements?

California, Delaware, Maine, Missouri, and New York legally require LLCs to have operating agreements. However, it’s a good idea to have one regardless of your state’s requirements.