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.”
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.
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.
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.
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!