How to Draft an LLC Operating Agreement

Chamber of Commerce Team
Sun, 22 Oct 2023 16:26:21 +0000
Starting a business, operating agreement

Starting an LLC or limited liability company can be quite a challenge, and one of the critical aspects of doing so is drafting an LLC operating agreement.

The good news is, drafting an LLC operating agreement isn’t all that hard, and anyone can do it. Read on to learn the steps for drafting your own LLC operating agreement and some tips for each section.

What is an LLC operating agreement?

An operating agreement is a legal document written to give a new or small business structure during the formation process. While the exact contents can vary from contract to contract, most operating agreements for LLCs contain the following.

The number of members in the LLC

The company name

The structure of the management of the LLC

The business purpose

How the various members of the LLC have invested

How the LLC will be taxed

How future profits will be shared among LLC members

Starting a business can be a costly endeavor, and an operating agreement is an internal agreement designed so that all those invested in the business can have a clear outline of how much they put into the business, as well as how they could expect to receive profits in return later.

For many businesses and startups, the operating agreement serves as a business plan, giving the members direction and purpose in the early days of operation.

It also dictates who will make decisions on behalf of the company as well as specifies how the business will deal with the loss or replacement of any of the members of the LLC if such a thing were to occur.

All multi-member LLCs, no matter in which state they are formed, are required to have an operating agreement. For single-member LLCs, operating agreements are sometimes required but are always recommended.

Why is an operating agreement important?

Operating agreements are critical in the operation of an LLC, as they are what sets them apart from a sole proprietorship. Operating agreements separate the finances and assets of the business from those of the members.

Besides just proving financial separation between the business entity and owners, an operating agreement also provides protection against personal liability. If an angry customer decides to sue an LLC, only the funds and assets of the LLC can be targeted, providing the owning members with protection for their homes and personal finances.

If you open a single-person LLC without an operating agreement, there is a chance that if something happens, you could be found to be operating a sole proprietorship rather than an LLC, leaving you vulnerable to losing personal assets and finances because of a mistake made by your business.

Additionally, many states have default laws when it comes to LLC operations. Your LLC will be subject to these default state laws if you don’t have an operating agreement in place.

For example, some states have default operating agreements which dictate that all members must share profits equally. So even if you put in twice as much initial capital as your counterpart members, you would share profits equally. Therefore an operating agreement gives you more control over your business.

Can I create my own operating agreement?

It is an option to write your own operating agreement for your LLC. While you should still plan to have a lawyer take a look, it is always easier to approach your lawyer with your information already written down.

If you are not the only member of your LLC, then it’s important to include all members in the operating agreement writing process. It’s a good idea to schedule a time for all of you to sit down and discuss the basics of what you would like to see in the agreement before hiring a lawyer.

What should an operating agreement contain?

There are many variations between operating agreements. However, there are some elements that are required for all operating agreements. Below are all of the required elements for a written operating agreement as well as some optional elements.

1. Ownership and ownership interest

The first step to writing your own operating agreement is to define the ownership of the various members and state the company name. If you have a partner, this could be splitting the ownership 50/50, or maybe because you contributed more to the initial funding, 75/25. You’ll want to discuss this with your other members.

Start by mentioning all members by name, listing their addresses, and giving them a title. These titles could be CEO, CFO, VP, or even just ‘partner’ if you will all share in the work equally.

After you have listed their basic information, list their partnership percentage.

Tips to write this section:

If you are operating a single-member LLC your owner percentage is 100%

Write this section only when all partners are present.

It can be helpful to have a list of who has purchased/contributed to which parts of the business to make listing percentages easy.

Specify in this section who is your registered agent.

2. Statement of intent

The statement intent is a legal statement in an operating agreement that states the purpose of an agreement and the fact that once it is filed with the official documents, the LLC will come to be.

Tips for writing this section:

If you aren’t an experienced legal writer, seek legal advice for help writing this section.

Look at the requirements for LLC operating agreements in your state; some may have a statement of intent you can use on your agreement.

3. Business purpose

After the statement of intent, you’ll need to state the business purpose. This statement should include information about what services/products your business plans to provide.

At the end of your business purpose, include the phrase? “and for any other lawful business purpose” to allow you to make changes in the future.

Tips for writing this section:

The business purpose doesn’t need to be very detailed, just a general statement of what your LLC plans to do.

It can help to look at examples of other LLCs online to get an idea of what to say for your business purpose.

4. Term

You must state the term of your LLC agreement. In most cases, the term is that your business will continue until terminated or dissolved. However, there are certain businesses, especially in politics which may only continue until a date, such as an election campaign.

Tips for writing this section:

If your LLC isn’t for a specific event, it’s best to write a continuing term until dissolution.

If your LLC is temporary, ensure you have very specific qualifications for what has to occur prior to dissolution (such as the sale of a building, etc.)

5. Tax treatment

LLCs have a few different options for taxes. Single-member LLCs can choose to be taxed as a sole proprietorship, for example, while multi-member LLCs can choose to pay taxes as a partnership or a corporation.

Outline how your LLC elects to be taxed in this section and how tax returns will be submitted. You’ll want to check local laws, as some states specify how certain LLCs must be taxed, while others allow the owners to choose.

Tips for writing this section:

Speak with a law firm if you have any questions, as making an incorrect tax selection can be costly.

Multi-member LLCs cannot be taxed as a sole proprietorship.

6. Rights and responsibilities

After you have designated the members and their ownership of the company, it’s time to outline rights and responsibilities.

This section goes far beyond terms like CEO and VP and should outline the specific duties of each member of the LLC. It should also outline performance requirements and the pay the individual will be paid for their work.

You can include a section about the voting rights of each member and how any disputes will be solved in this section, or save it for the option management structure section or membership meeting sections if you plan to include them later on. This section can serve as the bylaws of your LLC for day-to-day operation.

Tips for writing this section:

Include a list of daily activities for each member

This section will vary widely based on the specific needs of your business, so don’t get ideas from other LLC operating agreements.

Take this time to ensure each member understands what will be expected of them before the operating agreement is signed.

Check tax rules before determining how each LLC member will be paid.

7. Joining and leaving the LLC

While it would be best if all members stayed part of the LLC forever, this may not happen. When you create your operating agreement, you will want to specify how members can join and leave the LLC.

Include how new capital will be incorporated and how existing investments will fit in with new ones. You’ll also want to consider what a leaving member could take with them if they decide to leave the LLC. This could include their initial capital, profits, or shares in the LLC and more.

Tips for writing this section:

Check with the local Secretary of State before you write this section, as there may be some laws in your state about the governing members joining and leaving an LLC, which you must follow.

If you are a single-member LLC, leaving the LLC would result in an automatic dissolution.

Include the onboarding process for new members joining the LLC if you do not include this and want to add a partner at some point, you will need to make a whole new operating agreement.

You may wish to include a separate subsection for procedures upon the death of a member (who doesn’t leave of their own choice), which would include the distribution of their assets to a loved one or family member.

Consider the right of refusal to allow members to purchase the shares of leaving LLC members.

8. Profit and loss distribution

Although you have already specified who has invested what in the LLC, it is also required to outline profit and loss allocation among members. It is also a good idea to include how taxes will be paid in this section.

Tips for writing this section:

Most LLCs choose to divide profits and losses based on initial ownership percentages.

Specify when profits will be distributed and coverage for losses will be collected.

Tax a look at local LLC tax regulations before writing this section so you can ensure the percentage of profits distributed leaves enough to cover tax costs. In states with no state taxes, like Florida, this is less important than a state with a high state tax, like New York.

9. Buying and selling rules

There may come a time when a member of your LLC wishes to sell part of their ownership to another member of the LLC. This is allowed in some LLCs but can also be prohibited in this section.

Tips for writing this section:

Write this section with care, as allowing members to buy and sell their interests to one another can lead to future ownership problems.

You can specify when sales of ownership can occur as well as limit them so one or more owners retain the controlling interest.

You can include a right to refuse so internal members are given an option to buy available shares/interests before they are allowed for public sale.

It’s a good idea to consider what you would want to happen in the event of a buyout in this section.

10. Additional capital contributions

Many businesses launch only to find themselves in need of additional capital. You’ll want to outline what happens in these cases in the operating agreement.

Specify whether members are required to make additional contributions when needed or if it is an option and how the percentage of the shares in the business will be adjusted accordingly.

Tips for writing this section:

Required additional contributions can be a good way to secure future funding for your business.

Include the method of how additional contributions should be received and the time between when they are requested that they need to be submitted.

11. Dissolution

Not all businesses make it, and it’s important to plan for your LLC’s eventual dissolution or liquidation when you write the operating agreements. LLCs can be closed for several reasons, such as the members moving on, disagreements, or bankruptcy.

Include information about how the company’s debts will be paid and how assets will be split. It is also important to consider including a clause dictating if members of the former LLC can create similar businesses after dissolution.

Tips for writing this section:

Don’t forget to include a section of member duties in the event of a dissolution (who will pay the debts and oversee the division of assets?)

Dictate whether or not physical assets will be sold or divided between members as is (for example, will the building where the business is based need to be sold in dissolution, or will one of the members be able to keep it as part of the asset division?)

12. Severability

Your LLC operating agreement needs to include a severability clause. This standard legal clause states that if anything in the operating agreement is found to be against local or federal laws, the rest of the agreement will remain intact except for the contrary portion.

The severability clause is important because without it, if any part of the agreement is outside the law, the entire agreement will become invalid.

Tips for writing this section:

You can look up what this clause should look like in your state.

If you aren’t familiar with legal writing, this section may be best left to a lawyer.

13. Optional: Editing provisions

The business world is always changing, and it’s a good idea to add a section dictating how you or other LLC members can edit the operating agreement in the future.

If you omit this section, your LLC will have to rely on the state default rules on amendments if you ever want to make changes to your LLC.

Tips for writing this section:

Include provisions for when edits can be made, as well as how many LLC members must be present to do so.

You can include parts of the operational agreement that cannot be edited except by dissolution.

14. Optional: Member meetings

You can state when and where meetings will be held, as well as when and how votes will be taken during these meetings. Many people also choose to include a stipulation of how many members must be present for a vote to be taken.

Tips for writing this section:

A section about member meetings becomes more important with large member LLCs. If you own a single-member LLC, it is not required.

Ensure you don’t set the minimum number of members needed to take a vote too high, otherwise, you could impede the future actions of your LLC because of 1 or 2 members who miss meetings.

15. Optional: Management structure

A section on management will allow you to outline if your LLC will be member-managed or manager-managed. It will also allow you to state how and when managers will be chosen and term limits for electees.

Tips for writing this section:

Look up the differences between the types of managed LLCs before writing this section.

It can be beneficial to put limits on managerial power in this section.

Specify which actions need member approval versus those which only require management approval.

Include what would happen in the case of the death of a manager.

16. Optional: Capital contributions

Although the ownership of the LLC must be listed in the operating agreement, there is no requirement to list the exact contributions of each member. It can be helpful, in the case of dissolution, to have a list of contributions included in the operating agreement.

A section on capital contributions is especially helpful when not all business owners contribute cash, such as in the event someone has contributed a building, supplies, or a car to the business.

Tips for writing this section:

This section is typically not needed for single-member LLCs.

Have all members make a list of what they have contributed, both in cash and assets, and use it to write this section.

If you decide to include this section, it can be helpful to write it before the ownership section, as the member’s contributions can easily be converted into an ownership percentage.

17. Attach: Articles of organization or certificate of formation

While you won’t need to draft this, you will need to include both the articles of organization or certificate of formation when you file your operating agreement.

Articles of organization or certificate of formation is a legal document provided by the Secretary of State office stating you have legally registered your business and you are legally allowed to run it.

You will need this document in order to apply for a business bank account and an EIN from the IRS.

Also note that in many states, you will need to include your articles of organization (the document that gives you the right to use the business name you have chosen) when you submit your operating agreement.

If you are still confused about writing an operating agreement, take a look at our free LLC operating agreement template below.

LLC operating agreement template

Ownership/ownership interest: Names, addresses, and percentage ownership of all members.

Statement of intent: Legal statement establishing that the LLC is formed by this operating agreement.

Business purpose: Statement of your business purpose with the ending “and for any other lawful business purpose” to allow you to make future changes.

Term: Term of the LLC, usually until terminated or dissolved.

Tax treatment: How the LLC will file taxes.

Rights and responsibilities: List the member’s rights and responsibilities as part of the LLC.

Joining and leaving the LLC: How new members can join the LLC or existing members can leave. Include the process which occurs at the death of a member.

Profit and loss distribution: How much and when will members receive profits, as well as how losses will be paid.

Buying and selling rules: Any rules regarding members buying and selling their interest to other members of the public.

Additional capital contributions: Whether or not future capital contributions will be required and how the resulting equity will be handled.

Dissolution: How the LLC can be dissolved, and under what conditions.

Severability: A legal statement protecting the operating agreement in case any part of the agreement is found to be against the law.

Optional – Editing provisions: Whether or not the operating agreement can be edited and under what conditions.

Optional – Member meetings: An outline of when meetings will be required and how the meetings will run.

Optional – Management specifications: The process of becoming a manager and how long that individual will remain a manager. Also, include what happens if a manager dies.

Optional – Capital contributions: Outline the capital contributions of all members, including both assets and cash.

Remember to attach the articles of organization or certificate of formation.