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What to Include in Your LLC Operating Agreement?


An introduction on how to format your operating agreement and terms you should know

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Are you ready to start your new business venture? Perhaps you live in one of the five states (California, New York, Maine, Delaware and Missouri) that require you to file an operating agreement if you intend to form a Limited Liability Corporation (LLC).

Or perhaps you're discerning enough to know that a controlling legal structure will benefit your business, even if you live in one of the forty-five states where such an agreement is optional and where articles of incorporation are the norm.

Continue reading to learn more about the similarities and differences between operating agreements and articles of incorporation.

Now, you may be wondering what all has to be included in your operating agreement. 

While the exact requirements will vary from state to state, there's a basic outline for both structure and terminology and that will be similar nationwide. That structure can best be understood by reviewing how we've broken it down below.

Operating Agreements: Key Terms and What To Include

An operating agreement should include the following information:

Basics

  • Name Of The LLC. First, you'll have to give the official name of your business and then thereafter refer to it as “The Company” in your operating agreement.
  • Term Of The Agreement. Specify how long the agreement will remain in force. The typical term is “indefinitely.”
  • Formation Date. State the date of formation.
  • Principal Address. Identify where the main office will be located

People

  • Member Information. This section is usually pretty basic; just be sure to include the name and address of each LLC member.
  • Liability. This will typically be language that moves liability off of individual members and onto the LLC as a whole.
  • New Members. Lay out the process by which a new person can buy into the LLC.
  • Members' Rights & Responsibilities. The rights as well as the duties of LLC members should be outlined in the operating agreement.

Money

  • Raising Capital. Discuss the process to raise capital; this will often be folded right into the New Member processes, as raising capital is the usual reason for recruiting new members.
  • Transfer Of Interest & Withdrawal. Specify the process by which an individual member can leave the LLC; this is often done for estate planning reasons.
  • Distribution. Determine the timetable and process for distributing profits. The amount and timing of distributions to members should be included in an LLC operating agreement. This deserves particular attention since the members' financial situations may differ, and with “pass-through” tax treatment, “Phantom Income” often comes as a rude shock.
  • Profit/Loss Allocation. As in the case of most other business entities, one would expect profits, losses, and any other tax consequences to be allocated based on the members' percentage of ownership. But in an LLC, these allocations can be as set forth in the operating agreement and they can be disproportionate to the members' ownership.
  • Ownership Percentages. Contributions of cash, property, and/or services are made by LLC members to initiate the business. Although, as with other business entities, members would normally own a percentage of the LLC based on the percentage of their contributions, such is not necessarily the case in an LLC. LLC members can determine the percentage of ownership in any way they choose.

Management

  • Management Structure. While an LLC is generally managed by its members, they can be “manager managed” by one or more managers who may or may not be members. The specifics surrounding manager management should be set forth in the LLC's operating agreement.
  • Format. You'll need to decide early one whether the LLC will be run by a board or a single manager. If it's a board, say how many people will be on it.
  • Managerial Qualifications. Do all managers have to be members of the LLC? Are there any other qualifications your ownership group wants in place? Answer these questions in this section.
  • Process Of Election. Determine the procedure for electing new management to your LLC.
  • Fiduciary Responsibilities. What are the contractual obligations of management? What standard of care are they obligated to provide?
  • Management Powers. Outline what decisions management can and cannot make. It's also important to spell out whether there are any specific requirements for action to be taken.
  • Voting. Although many decisions in an LLC can be made informally, the operating agreement should indicate under what circumstances voting is required, the number of votes needed for a decision, and whether each member is to have one vote or voting power is to be determined based upon percentage of ownership.
  • Meetings. State how often meetings will be held.

Resolution

  • Resignation & Removal. Clearly state the procedure to be followed when a board member wants to leave, or the rest of the board wants them out. It is important that LLC operating agreements include what will happen when a new member is added as well as when a member dies, becomes disabled, retires, or simply wants to sell their ownership. Any rights and/or obligations to purchase a member's ownership under certain circumstances should also be covered.
  • Mediation & Arbitration. Inclusion of this section might be what protects the LLC from costly litigation.

Termination

  • Dissolution. Determine the process for terminating the business relationship. An LLC operating agreement should also address if/when/how the operating agreement itself can be amended as well as if/when/how the LLC is to be dissolved.

Are You Required to Create an Operating Agreement?

While no state requires an LLC to file their bylaws or operating agreement with the Secretary of State office, there are five states that do require you to create them and keep them with your business records. These states are:

States Requiring LLC Operating Agreements
California California LLCs are required to have either an oral or written operating agreement. If written, the agreement must be stored with the company's records.
New York New York LLCs must have a written operating agreement, which includes provisions relating to the business of the LLC, the conduct of its affairs, and the rights, preferences, limitations, or responsibilities of its members.
Maine Maine LLCs must create an operating agreement before, after, or during the time of filing for an LLC. This agreement can be written, oral, or even implied. Clearly, it's a fairly lenient law, but still technically a requirement in Maine.
Delaware Delaware LLCs must create an operating agreement before, after, or during the time of filing for an LLC. Like Maine, this agreement can be written, oral, or even implied.
Missouri Missouri LLCs (like New York) must create either an oral or written operating agreement. The document should cover the conduct of the business, the affairs of the LLC, and the rights, powers, and duties of its members, managers, agents, or employees.

Conclusion

We have addressed, in a very general way, some of the most important things an LLC operating agreement should include. Your attorney and accountant should be able to help you create one that covers all of the bases and ensures the best possible results for you and any other owners. Investing the time and resources required to create an LLC operating agreement designed to meet your specific needs will pay big dividends for years to come.

Ready to start your operating agreement? Form an LLC Online now.