ACROBAT | 5-MINUTE READ
Operating agreement: What is it and what to include?
An LLC operating agreement creates a management structure for partners and business owners. Learn what is commonly in an operating agreement and why every LLC usually needs one.
What is an operating agreement?
An operating agreement is a document used by limited liability companies (LLCs) to define roles, responsibilities, and liabilities for the business. This includes basic information for the LLC, such as the business address and contact information for each partner. It also outlines how much each partner owns, what happens if a new partner joins the organization, and what steps to take if a partner wants to exit the LLC.
Operating agreements also sketch out how the LLC will be managed at a high level. They provide liability protection and include specific needs for the LLC.
Operating agreements aren’t just for multi-member LLCs and large organizations. Even small businesses and single-member LLCs can benefit from having written bylaws. Often, if an LLC does not have a written operating agreement at the time of LLC formation, then the company would look to its state default rules. These documents vary in structure and tend to be anywhere from 10–20 pages long.
Key elements of an LLC operating agreement.
An LLC operating agreement is a foundational document that establishes the rules, rights, and responsibilities governing a limited liability company. While the specific content may vary based on state laws and business needs, a well-drafted operating agreement typically includes several essential sections. Below are the key elements that should be included:
1. Business structure and ownership.
This section outlines fundamental details such as the LLC’s name, principal place of business, and purpose. It also specifies the ownership structure by listing the members and their respective ownership percentages.
2. Management and decision-making.
The agreement should define whether the LLC will be member-managed (run by its owners) or manager-managed (overseen by appointed managers). It also details voting rights, decision-making procedures, and how authority is distributed among members.
3. Capital contributions.
This section documents the initial and future financial contributions of each member, whether in the form of cash, property, or services. It may also outline procedures for additional funding or capital calls if needed.
4. Profit and loss allocation.
The operating agreement must clarify how profits and losses will be distributed among members. While most LLCs divide them based on ownership percentages, members can establish alternative arrangements if desired.
5. Membership changes.
A well-structured operating agreement includes guidelines for admitting new members, transferring ownership interests, and handling voluntary or involuntary member withdrawals. It also defines what happens in the event of a member’s death, disability, or bankruptcy.
6. Dispute resolution.
To prevent internal conflicts from escalating, the agreement should outline dispute resolution mechanisms, such as mediation or arbitration, before legal action is taken.
7. Dissolution and exit strategies.
This section specifies the conditions under which the LLC may be dissolved, such as unanimous member agreement, financial insolvency, or legal requirements. It also provides a framework for liquidating assets and distributing remaining funds.
8. Operating procedures and miscellaneous provisions.
Additional operational details, such as meeting requirements, record-keeping policies, and non-compete clauses, can be included to ensure smooth business operations.
Benefits of an operating agreement.
Operating agreements allow the partners of an LLC to run their business the way they want rather than to adhere to a state’s preexisting framework for running an LLC. Having this information in writing enables parties to have a common understanding to refer to. With the new contracts experience from Acrobat AI Assistant, your work with contracts can be made simple with one easy app.
An LLC operating agreement is more than just a legal formality; it’s a crucial document that helps define how your business is structured and managed. While some states don’t legally require LLCs to have one, having a well-crafted operating agreement can protect your business, streamline operations, and prevent disputes. Here are some key benefits of having an LLC operating agreement:
- Establishes clear ownership and roles. Clearly defines each member’s ownership percentage, responsibilities, and decision-making authority.
- Prevents internal conflicts. Outlines procedures for resolving disputes, removing members, and handling disagreements before they become major issues.
- Protects limited liability status. Helps reinforce the legal separation between the LLC and its owners, ensuring personal assets remain protected.
- Defines profit and loss distribution. Specifies how profits and losses are allocated among members, avoiding confusion or disputes over financial matters.
- Provides customizable business rules. Allows LLC members to create operating rules that fit their specific needs instead of relying solely on default state laws.
- Clarifies membership changes. Sets guidelines for adding new members, transferring ownership, or handling situations like a member’s departure or death.
- Ensures smooth business operations. Establishes clear procedures for decision-making, voting rights, and management responsibilities to keep the business running efficiently.
- Outlines dissolution procedures. Defines what happens if the LLC needs to close, ensuring an orderly process for asset distribution and legal compliance.
Frequently asked questions
Is an operating agreement legally required?
Can a single-member LLC have an operating agreement?
What happens if an LLC doesn’t have an operating agreement?
Can an operating agreement be changed?
Does an operating agreement need to be filed with the state?
Keep exploring