LLC Operating Agreement Guide

Document of Operating Agreement

Though legal requirements of operating agreement do not exist in most states, it is critical to write this document in order to have a clear understanding of what is expected, protect rights of the members and avoid unnecessary expensive litigation. This is a complete guide about the nature of operating agreements, their importance, what they need to contain, and how you can write an operating agreement that can help you safeguard your business.

An LLC Operating Agreement What is a LLC Operating Agreement?

An operating agreement is the internal governing document of your LLC, which establishes the structure of ownership, the management process, the financial structure, and the working procedures. This document, although not usually submitted to the state, and is often a secret amongst members of the same, carries heavy legal consequences in regulating your business relationship.

Operating agreements are especially important in case of multi-member LLCs as they determine the percentage of ownership of the individual members, methods of sharing profits and losses, roles and responsibilities and how to go about the process of making key decisions affecting the business as well as making changes to the members.

A single-member LLC can benefit greatly directly through operating agreements as they assist in preserving of the corporate veil between personal and business assets, prove that the LLC is operating legitimately in the eyes of the banks and investors and offer a clear succession strategy in the event that the owner faces incapacitation or death.

The reasons why an operating agreement is required

The use of operating agreements has several important purposes that can save your business and your personality against possible issues. In the absence of this document, your LLC will fall under default LLC statutes in your state, which are not necessarily what you would prefer or that are based on the needs of your business.

An extensive operating agreement covers many situations such as business mergers or acquisitions, departure or death of a member, major strategic decisions, resolving of disputes and altering the ownership structure. When in a dispute, you can always get out because you have already recorded agreed-upon procedures in advance.

The operating agreement officially incorporates the ownership share, profit sharing percentage and distribution privileges of each member. Such clarity can be extremely helpful when it comes to allocating the profits or revenues gained out of the sale of the business and all the member members know their rights and do not dispute over the business finances.

Also, operating agreements specify decision making process and conflict resolution processes. They also make clear what decisions should be unanimously accepted and only special majority approved, and they put in place the means of dealing with conflicts before they turn to be costly legal tussles.

In the absence of an operating agreement, state default legislation regulates the operation of your LLC and dispute resolution. Such generic laws can require the court interference in case of internal disputes which can be costly litigation, ruined business relationships and the negative overall outcomes by all parties.

Key Facts of LLC Operating Agreement

A good operating agreement must deal with ownership, management, finances, operations and contingency planning. Although there are certain needs that are business specific, the following points must be present in virtually all operating agreements.

Membership Data and Organization

The complete member information and rights should be well documented in your operating agreement:

• Member Rights and Responsibilities: It is apparent to state the authorities, duties, obligations, and limitations of every member of the LLC. Identify the participation levels, time investment, and particular duties to be assigned to the individual members.
• Capital contributions: Record the amount or the value that each member brings to the LLC at the original formation, the nature of the contributions made (cash, property, services, intellectual property), and the percentage of ownership that each contribution gives.
• Member additions and removals: Develop specific protocols of the admission of new members, the prerequisites of their membership, and the expectations of their capital contribution as well as the valuation of interest in membership. On the same note, document procedures of voluntary withdrawal of members, involuntary withdrawal of members, buy out, and valuation procedures.
• Member transfer restrictions: Establish the circumstances in which members can either sell or transfer its ownership interests. Consider that there are right of first refusal clauses, permission requirements on transfer to outsiders and restrictions on transfers to preserve desired ownership structure.
• Succession planning: Deal with situations in which members die, get handicapped or are declared bankrupt. Determine the passing of membership interests to the heirs or the return to the LLC, determine the conditions of buyout and outline how the successor members are admitted or paid.

Management and Decision- making

Establish the manner of the management of your LLC and decision making:

• Management structure: Indicate the type of management structure to be a member-managed (where all members are involved with the operation) or manager-managed (where specific managers will make the operational decision). In the case of manager-managed structures, find out who is the manager, his/her level of authority, and how he/she is appointed/removed.
• Voting rights and procedures: Report all the voting rights of each member, whether the votes are proportionate to the percentage of ownership, or have different distributions. Indicate the decisions that must be unanimously approved, by super-majority, or by simple majority of votes.
• Satisfying requirements: Provide guidelines on schedule of member meetings such as the notice requirement, quorum requirement, voting procedure and documentation requirements. Handling of regular scheduled meetings and other special called meetings.
• Policies relating to conflict of interest: Develop a clear guideline on how to deal with cases where the personal interest of members and LLC interests clash. Encompass disclosure, recusal and authorization of conflicted transactions.

Financial Provisions

Most disputes of LLC are avoided by financial clarity:

• Profit and loss allocation: Determine the way that profits or losses are divided amongst members. Although the allocation is normally in accordance with the percentage of ownership, in your operating agreement, you may choose to do otherwise as long as the members are willing.
• Distribution procedures: Determine the timing and method of distributions made by the LLC to its members, who is entitled to make distributions, the cash reserve requirements, and any limitations on the time and amounts of distributions.
• Tax treatment: Select the tax treatment of your LLC. By default, LLCs pay tax as pass-through taxable (similar to sole proprietorships or partnerships), although may choose to be taxed as corporations (C-Corp or S-Corp) where it is advantageous to them.
• Financial audits and reviews: Determine the periodical financial reviews or audits, the person doing it, and access controls on financial records and statements by members.
• Additional capital contributions: Treatment of additional capital being made, such as whether it is mandatory or optional to be made, the effect on members who fail to make additional contributions, and the impact of this on ownership percentages.

Operational Guidelines

Set organizational operating procedures and policies:

• Business purpose and activities: Checks and balances: Be very specific about what your LLC can or cannot do in business and any restrictions on scope of business.
• Record keeping requirements: State record maintenance requirements, record retention and member access permissions to company records, adhering to state recordkeeping laws.
• Communication protocols: Stipulate how decisions that are made in the company are recorded and passed to the members, in a form of meeting minutes, written consents, email notifications, and any other accepted communication avenue.

Amendments, Dissolution and Changes

Provision of an eventual dissolution and plan of changes:

• Procedures to make amendments: Develop procedures to make amendments to the operating agreement, such as, proposal procedures, minimal approval requirements (usually supermajority or unanimous), and documentation requirements.
• Merger and acquirement policy: In the event that there is any, describe policies and approvals of potential mergers with other firms or the acquisition by external sources.
• Dissolution procedures: Document conditions which will prompt dissolution of an LLC, 3-phase wind-down and liquidation process, priority of payment to creditors, and distribution of the remaining assets to the members based on applicable state dissolution laws.

Legal Policies and Legal Protections

Insert clauses which safeguard the LLC and its members:

• Dispute resolution procedures: Have procedures to resolve disputes between members, which may involve necessary mediation or arbitration prior to litigation, a means of selection of a mediator or arbitrator, and cost to resolve a dispute.
• Non-compete and confidentiality contracts: Establish the expectation on the protection of proprietary information, trade secret protection, and limitations on the participants who can be involved into competitive business practice during and after membership.
• Indemnification provisions: Provide requirements of cases when the LLC can indemnify members, managers, or employees, who act on behalf of the company, and lay down the parameters of the liability.

Registered Agent and Administrative Data

Included: necessary administrative data:

• Identification of registered agent: Enter the name of the registered agent and the address of the registered office of LLC as required by state law.
• Principal location of office: Indicate the principle place of business of your LLC.
• Name of the fiscal year: Specify the accounting and taxable fiscal year of your company.

How to Create an LLC Operating Agreement

There are a number of methods to format your operating agreement, varying in terms of cost and complexity:

Filling Operating Agreement Templates

LegalZoom, Rocket lawyer, and ZenBusiness are online legal service providers providing free to hundreds of dollar templates of operating agreement. These templates offer general legal terms and enable you to tailor the provisions by inserting the business-related information.

Although templates provide economical solutions to simple single-member LLCs or simple multi-member LLCs, they might not suit the complex situations and other ownership holdings. Always make sure that any template meets regulations and laws of your particular state.

Hire an Attorney

When the LLC is more than a member or the business has an intricate owner structure, special circumstances or large assets, it is highly advisable to employ the services of a skilled business counsel. Attorneys guarantee that all the details of all that is required are covered, tailor it to your experience, and make sure that it complies with the state-specific laws as well as guarding the rights and interests of all its members.

Attorney fees vary significantly depending on complexity and location. Although this is a considerable investment at the start, this will help avoid extremely expensive disputes and legal issues later on.

Articles of Organization vs. Operating Agreement

The two documents are used in different purposes to make your LLC operation and formation:

Articles of Organization are documents that you submit to the state that are external and in which you are registering your LLC. They are included in the general files and include the bare minimum details about your company name, address, registered agent and general purpose of the business. Articles of Organization create a legal entity of your LLC.

The Operating Agreements are internal reports, which are kept confidential by the members of the LLC. They are not registered with the state and include extensive data on ownership structure, management processes, financial organization and operational policies. Operating agreements are what regulate the day to day operations of your LLC.

Maintain Your Operating Agreement

Your operating agreement must change with your business and the changing circumstances. Check your operating agreement regularly- at least every year or every time there are changes to your business or the law which affect it significantly.

The situations under which operating agreement reviews or amendments would be advisable are:

• The addition or deletion of LLC members.
• Large variations in the member ownership percentages.
• Reforms in management or assigned managers.
• Changes in profit sharing schemes.
• Modifications in the state LLC legislation that impacts on your operations.
• Large business extensions, contractions, or change of strategic direction.
• Changes or conflicts in the relationships of the members that require to be addressed.

The operating agreement that you are employing must have procedures of amendment procedures, and this is usually a vote by members with a specified threshold of approval (usually unanimous or super majority). All amendments should be done in writing with all the signatures of the approving members and be distributed to all members and one copy retained in your corporate books.

Do not Operate Without an Operating Agreement

Although you are not legally bound to be operating with an operating agreement in the majority of states, you are risking your business unnecessarily. Intelligent entrepreneurs acknowledge that this document offers invaluable security to their investment and averts what may be catastrophic conflicts.

This may be one of the assumptions you make, that there will never be a dispute particularly between friends or family members going into business together. Nevertheless, business situations and even human relationships are bound to vary as time progresses. Even the best relationships suffer because of financial strains, conflicts of approach, lack of equal contribution to the work, or even change in personal lives.

An operating agreement that is formed when everyone is in agreement offers a dispassionate platform to which a dispute can be resolved before emotions can take over. In the absence of this structure, the members can potentially engage in costly litigation in which the courts use generic state default regulations that will not please either side.

Defend your business, your investment, and your relationships with the members by developing a comprehensive operating agreement on the first day. Thousands of dollars in legal expenses and maybe very important business relations can be saved by this, one document.

Frequently Asked Questions