Starting a business can be an exciting journey, and choosing the right structure is a key part of the process. If you've opted for a limited liability company (LLC), you might wonder, "What is an LLC operating agreement?" This document is more than just a formality — it's the cornerstone of your LLC's governance. In this post, we’ll review what a limited liability company operating agreement entails, why it's indispensable for your business, and how it protects your interests.
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An LLC operating agreement is the legal document that establishes the basic structures, procedures, and member rights and responsibilities of your business. The operating agreement codifies essential facts such as:
Depending on the size and complexity of your LLC, the operating agreement might be only a few pages, or it could be 20 pages or more. Many business owners use an attorney to help them draft their operating agreement, but it’s not required. Operating agreements are considered private business documents and are not usually shared with the general public.
In all but a handful of US states, LLCs are not legally required to have operating agreements, nor are they required to file them with regulatory authorities. So why have one?
According to the US Small Business Administration, an LLC operating agreement is critically important for several reasons:
Thus, even if it’s not legally required, an LLC operating agreement is a critical first step to creating a stable business and minimizing legal risk. Next, let’s take a closer look at what’s actually in an operating agreement.
An operating agreement for an LLC outlines the key components and guidelines for running your business smoothly. Here’s a breakdown of the essential elements you should include:
Define each member's ownership percentage. You should also specify how ownership can change and what happens if a member wants to leave.
Detail how you’ll manage your LLC. Will it be member-managed or manager-managed? Clarify each manager's roles and responsibilities.
Explain how voting rights are allocated. Who can make decisions, and what voting process will you use?
Outline the contributions each member has made and any future contributions expected. This includes cash, property, or services provided.
Specify the rights and duties of each member so everyone knows their role and obligations within the LLC.
Describe how you will share profits and losses among members. Will it be based on ownership percentages or another method?
Establish the process for admitting new members and include any qualifications or procedures they must follow to join.
Set guidelines for transferring ownership interests. What conditions can a member sell or transfer their stake under?
Detail the steps for dissolving the LLC. What happens to the assets and liabilities? How will the final decisions be made?
Provide methods for resolving disputes among members. This might include mediation or arbitration procedures.
Ensure members agree to confidentiality and non-compete terms to protect the LLC’s interests and trade secrets.
Explain the recordkeeping and accounting practices the LLC will follow. Who’s responsible for maintaining records and handling financial reporting?
Earlier, we outlined some of the ways that an LLC operating agreement can offer numerous advantages and benefits your business. Here’s a closer look at why incorporating an operating agreement into your business structure is a smart move:
When you craft an operating agreement, you have a clear framework for your business operations. It defines each member's roles and responsibilities, outlines decision-making processes, and establishes guidelines for day-to-day activities. This clarity helps prevent misunderstandings and ensures everyone knows their duties.
You can tailor the agreement to reflect your LLC's specific goals, processes, and values so you can create a document that truly represents your business vision.
An operating agreement can help reinforce the separation between your personal and business assets. If your business incurs debt or faces a lawsuit, your personal assets — e.g., home, car, savings, etc. — aren’t at risk.
You have greater control over how your business is managed with an operating agreement. You can establish specific rules for everything from voting rights to profit distribution, ensuring the business operates according to the members' wishes rather than default state laws.
Without an operating agreement, your LLC is subject to your state’s default rules, which may not be in your best interest. When you draft your own agreement, you avoid these default provisions and create a governing document that aligns with your business objectives.
Having a well-drafted operating agreement shows that your LLC is well-organized and professionally managed, which can attract potential investors, partners, and clients.
An operating agreement makes it easier to scale your business. Whether you’re bringing in new members, expanding
While LLC operating agreements offer several benefits, you should be aware of some potential drawbacks. Here are a few considerations to keep in mind:
Creating a detailed agreement often means legal fees and a lot of effort to cover all business aspects. However, this upfront investment can save you from costly disputes and complications in the long run.
The drafting process can sometimes lead to disagreements among members. Differences in opinions on roles, responsibilities, and business operations can create friction, so work together and communicate clearly to make sure everyone feels heard and valued. Resolving these disagreements can be painful and laborious, but it’s necessary work in creating a stable business that’s built for the long haul.
The basic process for drafting an LLC operating agreement works like this:
Remember that creating an operating agreement is one part of how to start an LLC, and you’ll also be responsible for steps such as drafting articles of incorporation and designating a registered agent.
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