The LLC Operating Agreement
Create an operating agreement to limit your liability and more.
An LLC (limited liability company) operating agreement allows you to structure your financial and working relationships with your co-owners in a way that suits your business. In your operating agreement, you and your co-owners establish each owner's percentage of ownership in the LLC, his or her share of profits (or losses), his or her rights and responsibilities, and what will happen to the business if one of you leaves.
For general information on limited liability companies (LLCs), see LLC Basics.
Why You Need an Operating Agreement
While many states do not legally require your LLC to have an operating agreement, it's foolish to run an LLC without one, even if you're the sole owner of your company.
An operating agreement will help you guard your limited liability status, head off financial and management misunderstandings, and make sure your business is governed by your own rules -- not default rules created by your state.
Protecting Your Limited Liability Status
The main reason to make an operating agreement is to help ensure that courts will respect your limited personal liability. This is particularly key in a one-person LLC where, without the formality of an agreement, the LLC will look a lot like a sole proprietorship. Having a formal written operating agreement will lend credibility to your LLC's separate existence.
Defining Financial and Management Structure
Co-owned LLCs need to document their profit-sharing and decision-making protocols as well as their procedures for handling the departure and addition of members. Without an operating agreement, you and your co-owners will be ill-equipped to settle misunderstandings over finances and management. What's more, your LLC will be subject to the default operating rules created by your state law.
Overriding State Default Rules
Each state has laws that set out basic operating rules for LLCs, some of which will govern your business unless your operating agreement says otherwise. (These are called "default rules.")
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Many states, for example, have a default rule that requires owners to divide up LLC profits and losses equally, regardless of each member's investment in the business. If you and your co-owners did not invest equal amounts in the LLC, you probably don't want to allocate profits equally. To avoid this, your operating agreement must spell out how you and your co-owners will split profits and losses.
By writing an operating agreement, you can choose the rules that will govern your LLC's inner workings, rather than having to follow default rules that may or may not be right for your LLC.
What to Include in Your Operating Agreement
There's a host of issues you must cover in your LLC operating agreement, some of which will depend on your business's particular situation and needs. Most operating agreements include the following:
- the members' percentage interests in the LLC
- the members' rights and responsibilities
- the members' voting powers
- how profits and losses will be allocated
- how the LLC will be managed
- rules for holding meetings and taking votes, and
- buyout, or buy-sell, provisions, which determine what happens when a member wants to sell his or her interest, dies, or becomes disabled.
While these items may seem fairly straightforward, each requires you to make some important decisions, which you should spell out in your operating agreement.
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LLC Maker by
Attorney Anthony Mancuso.
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