Write the LLC Operating Agreement

How Do I Write an Operating Agreement?

So you are starting a LLC! Well its time to get some legal structure and organization in place for you. The operating agreement is the first step in getting your LLC organized! 

Here we go into some of the most common questions asked when you are setting up your LLC and drafting your operating agreement.

What's In This Article?

HOW TO WRITE AN OPERATING AGREEMENT

This article is provided for educational purposes only and may not contain all necessary provisions your business may need. We advise you to speak with a business attorney for full legal advice when preparing your operating agreement.

What is an Operating Agreement?

The operating agreement sets the rules and guidelines on how the owners (known as members) will run the business.

The primary purpose is to uphold the limited liability that the LLC provides in order to prevent piercing the corporate veil.  Similar to the bylaws of a corporation, the operating agreement structures the LLC while also defining the member’s rights and responsibilities associated. 

Do I Need an Operating Agreement?

Operating agreements are used with multi-member LLC’s due to their nature of outlining percent interest and roles. This is seen with both member-managed and manager-managed LLC’s. 

While an operating agreement is necessary for multi-member LLC’s, it is also essential for sustaining the validity and protection of single member LLC’s as well.

Not all states will require an operating agreement to form an LLC but it is highly recommended one is created in order to uphold the limited liability of the LLC.

Should I Use an Attorney?

An attorney is not necessary to use an attorney to write your operating agreement. It is highly recommended to speak with a business attorney to make sure your best interests are covered when drafting the operating agreement.

How Do I Write An Operating Agreement

There are many templates out there to get you started drafting your operating agreement. Be careful on which templates you find as they could be improperly worded or could lack some of the necessary provisions needed to protect your LLC.

To assist you in your search, check out any of the following credited tools that can assist you not only with your operating agreement, but also with properly setting up your LLC.

Or if you would like to start from scratch and write your own, below are the common provisions that should be included within your operating agreement.

What should be included in the Operating Agreement?

A typical operating agreement would contain at least the following provisions:

1. General Business Details

The first section of the operating agreement states the general business information such as Name of the Business, Address, Registered Agent Information, and the overall business purpose. 

A quick tip: The business purpose does not have to be specific and can be very general such as: “To engage in any lawful business for which limited liability companies may be organized in this state.”

All of this information will already be stated within the Articles of Organization when filing the LLC.

For more information on the Articles of Organization, click here.

2. Capital Contributions

One of the most important sections of an operating agreement is the capital contributions. This section sets forth how much money or property each member will contribute to the LLC either now or in the future. 

Contributions will include monetary investments and property such as physical computers, land, or any other physical assets. Knowledge and skill sets could also be included through not deemed capital value, but still essential for the company’s overall success.

Not only will current contributions be addressed, but any future contributions are to be included as well.

3. Management

This section is to specify how the LLC is to be managed. Such management types would be either:

  • Member-Managed: This is the default and typical management method election for most small business LLCs.
  • Manager-Managed: Less common election for a small business and used for when an employee of the LLC manages the business. If you elect this option, you will need an additional section outlining how managed are selected, replaced, and what authority they will have.

4. Membership & Voting Details

The operating agreement of an LLC should include details about each member’s percent interest along with their respective voting details on how issues are decided. 

Typically this can be based on their respective capital contributions. For a member-managed LLC, a simple majority (51% or more) of the membership interest is needed to decide the issue. 

Voting can also be done on a per capita basis which means each member is given one vote no matter the capital contributions provided.

5. Tax Elections

Your operating agreement is to indicate how the LLC is to be taxed. Here the LLC can be taxed as a partnership (default) or as a corporation. Each comes with their own tax benefits.

It is recommended you speak with your tax advisor based on your unique business model for advice for selecting tax elections with your LLC.

6. Distributions and Profits & Losses

This will state how profits and losses will be allocated to each of the members within the LLC and how often will these distributions occur.  Elections can be weekly, monthly, quarterly or in certain amounts.  

All distributions elections must be stated within the operating agreement.

7. Transfer of Membership Interest

This provision describes how ownership will be transferred to another owner or add additional owners.  

For example, if an additional business partner is to be added in the future, this section will outline the circumstances when ownership can be transferred, what steps need to be taken to do so, and anything else associated with transferring ownership. 

This will also apply for if a member elects to withdraw their interest.

8. Buyout Provisions

If a member dies, moves away, gets sick, or simply wants to exit the business, this section will outline the requirements to buy the member out.  

For example the LLC could force the departing member to sell his or her interest to the remaining members and specify a timeframe to do so.  It will also outline how this will be valued and any other associated details.  

As a note this information may also be found in a buyout agreement.

9. Amendments

If you wish to make any changes to the operating agreement, this section will describe the process and how any amendments are to be processed.  Here it can be noted if consent may be required to approve the amendment if more than one member is involved.

10. Liquidation and Dissolution

Lastly, when and how should the LLC be dissolved if decided by the members.  This will include voting rights (unanimous or majority) and include all the steps to be taken to properly dissolve the LLC such as liquidation of assets and other associated properties.

Wrap Up

Overall the above are some of the key provisions your operating agreement should contain. Please note your business may have some unique aspects that should also be outlined. 

You can state any other additional provisions that are to be included such as indicating members are free to work with other businesses, or note how meetings are to be conducted. It is up to you on what you feel is am important element of your business that should be properly defined.

Remember the operating agreement can always be amended in the future so you do not need to make sure you have all details within the first iteration. It does not have to be perfect in the first draft! Sometimes keeping it simple when starting may alleviate the headache and delay of getting yourself started. 

As the world of business changes, your company should also change thus some aspects and other areas will follow. Your operating agreement will also change as your business expands and grows.

Good luck with your next adventure and enjoy the world of being an entrepreneur!

The Articles of Organization for an LLC

Starting a business and wondering what are the Articles of Organization for an LLC? In short, it is a simple key document required to be filed for your LLC to get started.

What are the Articles of Organization?

The Articles of Organization is a simple document that contains the key details of your LLC and is used when filing for the LLC with your state. Typically the state you are filing the LLC in will provide you the Articles of Organization form. You will be able to complete the form online making it a quick efficient process.

What is included in the Articles of Organization?

Typically the Articles of Organization for an LLC will contain the following:

1. Name of your LLC

This is the fun part where you get to pick a name for your LLC. The name will have to comply with state legal requirements and will require the designator “Limited Liability Company” or “Limited Company”. In most states the abbreviation LLC will also be accepted.

Here are some name variations below:

  • ABC Services Limited Liability Company
  • ABC Services Limited Company
  • ABC Services Limited Co.
  • ABC Services LLC  (Most Common Use)
  • ABC Services L.L.C.
  • ABC Services L.C.
  • ABC Services LC
  • ABC Services Ltd. Co.
  • ABC Services Ltd. Liability Co.

Warning: Your name will be rejected if it is already in use or very similar to another registered LLC. In this case you will need to choose a different name. Prior to submitting your LLC name, you can lookup all registered LLC’s on your state’s Corporation and Business Entity database prior to filing.

Check For Potential Trademark Conflicts

If the name is approved, it may still have potential trademark conflicts that should be checked. For example using “Starbuck” or “McDarrels” would be trademark infringements. It is recommended you conduct a national search to confirm the name is not going to cause any legal trademark violations. You can go to https://www.uspto.gov/trademark to access more information on trademarks.

Note: You do not have to be locked into your business name forever. If you would like to use an alternate name in the future, you can register the new name as an “assumed” or “fictitious business name” with the state.

Caution: Conducting a name availability check does not guarantee you the name. Not until the Articles of Organization for an LLC have been filed and accepted, the name is not yours. So wait on purchasing signs and business cards until all paperwork has been accepted.

2. Address of Business

As straight forward as it is, this section will ask you for your primary place of business. Here you will provide the address of your main business location. If you are a small business working from home, this will be your home address. If you are opening a storefront or office space, it will be the main location where your business will be conducted.

3. Name and Address of Your Registered Agent

Here you will provide the name and address of your registered Agent. The registered agent will the the point of contact where all legal documents will be sent relating to your LLC. This can be you if a resident of the state in which the LLC is to be registered. If you do not live in the state where the LLC is being registered, you will require a registered agent, or if you do not desire to receive all legal documents (for example being served for a lawsuit), you will want to elect to go forward with a registered agent.

Some very reliable registered agents would be Northwest Registered Agent LLCIncfileLegal Zoom, or Rocket Lawyer. These agents will not only assist with setting up your LLC but also offer services to partner with the overall legal compliance management. If you are just getting started, we suggest taking a look at some of these services to ease the process and confirm you are legally compliant when setting up your LLC.

4. Purpose

Here you will state your business purpose. Please note your purpose does not have to be specific and instead could be something like: “To engage in any lawful business for which limited liability companies may be organized in this state.”

5. Type of Management

This section is to specify how the LLC is to be managed. Such management types would be either:
  • Member-Managed: This is the default and typical management method election for most small business LLCs.
  • Manager-Managed: Less common election for a small business and used for when an employee of the LLC manages the business. If you elect this option, you will need an additional section outlining how managed are selected, replaced, and what authority they will have.

6. Duration of the LLC

This is how long will your LLC be active. Typically this is perpetual but in some states your LLC may have a cap of 30 or 50 years. In that case, you will renew for an additional period of time when needed.

7. Signatures of the members forming the LLC

Here the Articles of Organization becomes effective upon signature. With member-managed LLCs all initial members are to sign the articles of organization.

Submission

Upon completion of your Articles of Organization, you will submit this with your LLC filing for approval. Typically this is filed online and with your secretary of state’s office. In some states, (for example New York) you will be required to put a legal notice of publication in a local newspaper indicating the formation of the LLC.

Next Step: Complete the Operating Agreement

Your Complete Guide to Forming an LLC

For anyone looking to get started in their business, forming an LLC is a great way to begin.  The LLC provides you the legal protection of a corporation with the flexibility of a sole-proprietorship. 

Setting up an LLC is fairly quick and can be done at very low costs.  Follow the steps below to learn how to form an LLC.

What's In This Article?

Common Questions for Starting an LLC

To get you started, here are some common questions asked about starting an LLC.

A Limited Liability Company (LLC), is a legal business entity similar to a sole-proprietorship or partnership except it provides legal limited liability protection for the business owners and their personal assets. With an LLC, the owner of a business is personally protected against all business debts and court judgments.

The main benefit is the corporate veil that is created providing the legal protection of a business owner’s personal assets (home, car, personal bank accounts, etc..) and limit on personal liability. There are also some legal and tax advantages that can be applied as well compared to a corporation or sole-proprietorship.

People typically form an LLC when their business faces a chance of potential risk suck as a lawsuit. If your business operates in a field that has a high chance of getting a lawsuit, it is recommended to form an LLC for legal protection.

LLC’s are commonly used for small businesses and in real estate investing.

Although it is not required to use an attorney to file an LLC, it is recommended to have one review through your operating agreement to confirm proper state compliance for your business as well as to assist in protecting your best interests.

Typical costs to file for an LLC can range from $40 – $500 if filing yourself and depending on state fees. Alternatively there are also third party services that can do this for you at similar costs with additional enhanced service options.

With a typical LLC, only two documents need to be filed:

  1. The Articles of Organization (Also known as the “Articles of Formation” or “Certificate of Formation” in some states)
  2. Operating Agreement – Although this is not always required for filing, it is highly recommended to have this created.

    Read more about the required LLC paperwork

No, an LLC does not issue stock. Unlike a corporation with shareholders, owners of the LLC are called members. Instead of stock, members have their percent interest in the company. This is typically defined within the Operating Agreement.

LLC’s have the option to be taxed as partnerships or corporations.

The typical partnership LLC is taxed based on 100% of its earnings as a pass-through taxation. All earnings are filed on the members taxes at the end of the year.

See more about LLC taxes and distributions below

Getting Started – Setting Up Your LLC

Step 1 – Decide Members (Owners)

To get started, first you will need to identify if you are going to form the LLC as a:

  • Partnership (multiple members); or
  • Sole-proprietorship (one member).

This is where you will decide how many members will be involved.  If only you will be forming the LLC, a sole-proprietorship will be elected. The minimum number of members to form an LLC is one.

Do not be worried if you wish to add or remove a member in the future as this is a fairly easy process.  Typically the rules to adding/removing a member will be outlined in your Operating Agreement.  Also there is no need to notify the state when a new member is added as it will show on their tax records at the end of the year.

Step 2 – Elect Management

Depending on if you are going in with a partnership or electing to run your business on your own, you will need to decide how the LLC is to be managed. The typical default used is Member-Managed, where the members of the LLC oversee the day-to-day operations.

An alternate option is Manager-Managed where a separate level of management is elected and one or more people are appointed to manage the LLC. This election is less common for starting LLCs.

Step 3 – Obtain Financing

When looking to finance your LLC, you can either obtain it through two ways:

  • Debt (taking a loan); or
  • equity (also known as capital contributions)

Overall these are called Assets and will be outlined in the Operating Agreement when forming the LLC. Typically the amount contributed will define the member’s percent interest (capital) invested in the LLC. Also if the LLC must be dissolved later in time, this capital interest will determine the portion of LLC assets each member is entitled to.

Debt (Taking a Loan)

Taking a loan from a bank, friends & family, or other means is taking on debt. Loans can be very useful to enhance the LLC’s cash reserves or cover additional expenses.

Money taken as debt is not accounted for as income but instead a liability because it must be paid back and typically includes interest. Because of this, neither the LLC or members will pay taxes on it.

Example: In a sole-proprietorship, a $10,000 loan is made when forming the LLC. The loan has a 5% interest rate and is made repayable in monthly installments over a 36 month period. Repayment to the loan will include interest no matter if the LLC is profitable or not.

The LLC deducts the interest payments as a business expense reducing the overall profits and later total taxes paid on those profits.

Equity (Capital Contributions)

Capital contributions consist of cash, property, or services that is invested into the business from the start. This includes contributions to be made today, or in the future.

Capital investments into an LLC are normally tax free. No members have to pay taxes on their percent interest received and the LLC does not pay taxes on the capital it obtains. All taxes are deferred until later when the business is sold or dissolved. At the time of sale, exit, or dissolution, the exiting member(s) will be taxed on any profits made allocated by their percent interest initially invested.

Example: In a sole-proprietorship, a $10,000 capital contribution is made when forming the LLC. The forming member receives 100% capital interest in the business. Later when the business is sold for $80,000, the forming member is only required to pay taxes on the $70,000 profit ($80k – $10k = 70k profit).

Step 4 – Compensation Elections

Let’s Get Paid!

Deciding how money comes out of the LLC is the fun part! With an LLC you can elect to get paid either of two options:

Option 1 - Salary

With a typical partnership tax election LLC, the business can pay a reasonable salary (known as a guaranteed payment) to the members. The salary will be taxed as ordinary income and the LLC will deduct the distribution as a business expense against profits earned (i.e. Net Income). The remaining net income will then be distributed to all members.

Example: Member A and Member B have 50% ownership interest in the LLC. Member A receives a salary of $30,000 annually and Member B receives a salary of $40,000 annually. During the year, the LLC earns $100,000. At year end, Member A and Member B’s salaries are deducted as business expenses ($70,000 total). The LLC has no other business expenses outside of both salaries paid. Total remaining profit (net income) is $30,000 ($100,000 – $70,000 = $30,000). With 50% ownership, the $30,000 in remaining profit is then split evenly and distributed to each member.

Option 2 - Profit Distribution

If a salary is not taken as a guaranteed payments, then net profits will be distributed to each respective member of the LLC (known as the members “Distributive Share”). Distribution of the net profits will be determined by the percent ownership interest of each member or as otherwise stated within the Operating Agreement.

With the above example, the total $100,000 net profit of the LLC will be distributed evenly (50/50) based on membership interest. Both members would receive $50,000 at year end.

Step 5 – Select a Name

This is the fun part where you get to pick a name for your LLC. The name will have to comply with state legal requirements and will require the designator “Limited Liability Company” or “Limited Company”. In most states the abbreviation LLC will also be accepted.

Here are some name variations below:
  • ABC Services Limited Liability Company
  • ABC Services Limited Company
  • ABC Services Limited Co.
  • ABC Services LLC (Most Common Use)
  • ABC Services L.L.C.
  • ABC Services L.C.
  • ABC Services LC
  • ABC Services Ltd. Co.
  • ABC Services Ltd. Liability Co.

Warning: Your name will be rejected if it is already in use or very similar to another registered LLC. In this case you will need to choose a different name. Prior to submitting your LLC name, you can lookup all registered LLC’s on your state’s Corporation and Business Entity database prior to filing.

Check For Potential Trademark Conflicts

If the name is approved, it may still have potential trademark conflicts that should be checked. For example using “Starbuck” or “McDarrels” would be trademark infringements. It is recommended you conduct a national search to confirm the name is not going to cause any legal trademark violations. You can go to https://www.uspto.gov/trademark to access more information on trademarks.

Note: You do not have to be locked into your business name forever. If you would like to use an alternate name in the future, you can register the new name as an “assumed” or “fictitious business name” with the state

Caution: Conducting a name availability check does not guarantee you the name. Not until the Articles of Organization for an LLC have been filed and accepted, the name is not yours. So wait on purchasing signs and business cards until all paperwork has been accepted.

Step 6 – File the Paperwork

It is now time to begin working on the paperwork for the LLC. Typically only two legal documents are created when forming the LLC known as the Articles of Organization (Also known as the “Articles of Formation” or “Certificate of Formation” in some states) and the Operation Agreement. These documents will be submitted when filing the LLC within your state.

The Articles of Organization is a simple document that contains the key details of your LLC and is used when filing for the LLC with your state. Typically the state you are filing the LLC in will provide you the Articles of Organization form which can be completed and submitted online.

The Operating Agreement sets the rules for how the owners (known as members) will run the business while also defining their rights and responsibilities associated. Its primary purpose is to uphold the limited liability that the LLC provides in order to prevent piercing the corporate veil.

Similar to a partnership agreement or corporate bylaws, the Operating Agreement structures the LLC covering items such as finances, ownership details, and management responsibilities. Not all states require an operating agreement to form an LLC but it is highly recommended one is created in order to uphold the limited liability of the LLC.

Typically operating agreements are used with multi-member LLC’s due to their nature of outlining percent interest and roles. This can be seen with both member-managed and manager-managed LLC’s. While an Operating Agreement is necessary for multi-member LLC’s, it is also essential for sustaining the validity and protection of single member LLC’s as well.

Step 7 – Submit & File the LLC

Now all steps above and paperwork is completed, you may submit the LLC application with your state for acceptance.

Congratulations
on your LLC!

After the LLC is Formed

Once all documents have been submitted and accepted by your state, you will have some additional items to are either legally required to set up such as a business bank account, EIN number, make any publication notifications, and wrap up any unsettled finances. Review with your state guidelines that are necessary to complete the LLC.