In the US, over 50% of civil lawsuits involve small businesses, which is a shockingly high number. You’ve probably spent a great deal of time, energy, and money carefully building up your company, so don’t let everything disappear in one fell swoop.
Making sure everything’s legally squared away is a great way to increase your chances of success. If you have a limited liability company (LLC), or are considering one, then you’ll want to create an operating agreement.
In this article, we’ll discuss what an LLC operating agreement is and if it’s legally required for your company.
What Is an LLC Operating Agreement?
An LLC operating agreement is a legal document that outlines the ownership and operating procedures of an LLC. It’s a crucial document, as it establishes the framework for how the business will be managed and operated.
Here are the key components that are typically included in an LLC operating agreement.
Ownership Structure
This section defines the ownership interests in the LLC. It shows the percentage of ownership each member holds and the contributions they’ve made to the company, whether in the form of cash, property, or services rendered. This is important for clarifying each member’s stake in the company and their initial investment.
Management Structure
Depending on whether the LLC is member-managed or manager-managed, this part lays out the framework for how the company will be operated.
In a member-managed LLC, all members participate in the day-to-day management and decision-making. In a manager-managed LLC, certain members or external managers are appointed to handle management responsibilities. The operating agreement specifies the roles and authority of managers, if applicable.
Tax Treatment
By default, LLCs are treated as pass-through entities. However, you can opt to have it taxed as a C or S corporation.
The operating agreement clearly states what the company’s initial tax status is. In addition, it details the steps to take should you want to change the tax election later on.
Decision-Making Procedures
This part establishes the process for making important business decisions. It usually explains voting rights, quorum requirements, and procedures for passing resolutions on key matters such as admitting new members, amending the operating agreement, or making significant financial commitments.
Profit and Loss Allocation
The operating agreement specifies how profits and losses will be distributed among the owners. This may be based on each member’s ownership percentage or may involve special allocations based on agreed-upon criteria given in the document, such as capital contributions or special roles within the company.
Distributions
This section specifically governs the distribution of profits to the members. It outlines the timing and frequency of distributions, as well as any conditions or restrictions that may apply. For example, the agreement might specify that profits will be distributed quarterly or annually, or it may require certain profits to be retained for business purposes before distributions are made.
Rights and Responsibilities of Members
Here, you’ll see the rights, duties, and obligations of each member. This may include rights to participate in management, access company records, and share in profits. It also details responsibilities such as contributing capital, maintaining confidentiality, and adhering to fiduciary duties to act in the best interest of the company.
Buyout and Transfer of Membership Interests
This section addresses the processes for buying out a member’s interest in the company or transferring ownership to another party. It may establish valuation methods for determining the buyout price and outline conditions under which transfers are permitted, such as obtaining unanimous consent from the other members.
Dispute Resolution
The operating agreement includes mechanisms for resolving disputes that may arise among members. This could involve procedures for mediation, arbitration, or other forms of alternative dispute resolution to facilitate results without resorting to costly litigation.
Dissolution
Finally, this part details the process for dissolving the LLC if necessary. It specifies how to wind up the company’s affairs, liquidate assets, settle debts, and distribute the remaining funds to the members. It may also address any specific circumstances under which the LLC may be dissolved, such as bankruptcy or unanimous member consent.
Are Operating Agreements Required for LLCs?
Generally speaking, you aren’t legally required to make operating agreements for LLCs. However, the exceptions are the states of California, Delaware, Maine, Missouri, and New York.
Just because operating agreements aren’t mandatory doesn’t mean you should skip this step. In fact, there are many benefits that come with creating such a document. Below are the major ones to know about.
It Limits Your Liability
The nature of LLCs means you and your company’s assets are completely separate. But having an operating agreement can help limit your liability even more because it establishes you as a separate entity from your LLC and helps prevent personal liability for business debts and obligations.
This means that if your LLC is sued, your personal assets (like your house or savings account) are protected.
It Provides Clear Direction
In the event that one of the members of your LLC sues the company, the operating agreement can help resolve any disputes that may arise.
This also applies if a member is sued by a third party. The document should have provisions in place for what happens in this situation, including how any associated costs will be paid and whether the member will be required to step down from their position within the company.
It Promotes Financial and Operational Stability
By addressing key financial and operational aspects of the business (such as profit distribution, capital contributions, and decision-making procedures), the operating agreement promotes not only stability, but also consistency in the company’s operations.
It Helps With Legal and Regulatory Compliance
Operating agreements help ensure that the LLC complies with state laws and regulations governing LLCs. While not all states require these documents, having one in place can demonstrate that your company is operating in accordance with legal requirements.
It Allows for Future Planning and Contingency Measures
These documents often include provisions for handling various contingencies, such as the death, disability, or withdrawal of a member. These provisions can make transitions smoother and ensure the continuity of operations in the event of unexpected circumstances.
How to Create an Operating Agreement
We have a handy guide on how to create an operating agreement, which you should read carefully. However, if you want the gist of things, here are the steps:
- Determine ownership percentages
- Designate compensation details, responsibilities, and rights
- Define the terms of leaving or joining the LLC
- Define dissolution terms
- Add a severability clause
This might all sound very complicated, but you can easily find a suitable sample operating agreement for an LLC online. You can download and then customize the forms for your own company.
Or you can forget about finding an operating agreement template and use our business registration service instead. For a reasonable fee, we can put together your operating agreement so you don’t have to lift a finger.
Make Sure You Have an LLC Operating Agreement
Only a few states require that you have an LLC operating agreement. However, it’s in your best interest to have one. Since it can limit your liability as a business owner and provide some much-needed direction if your company hits a rough patch, it’s definitely worth spending some time creating a thorough document.
So whether you already have an LLC or if you’re thinking of starting one, be sure to draft up an operating agreement. It’ll cover all your bases and make operations much smoother.
Sign up now for Business Anywhere if you’d like to form an LLC. Our comprehensive services will make it easy to be a business owner.
