If you’ve formed (or are forming) a Limited Liability Company, you’ve probably heard about an LLC operating agreement. But what exactly is it, and do you really need one? In short, an operating agreement is a private document that details how your LLC functions internally – from ownership percentages to how decisions are made. Unlike the Articles of Organization you file with the state to create your LLC, the operating agreement is not submitted to any government agency (in most states). However, that doesn’t mean it’s not important. In fact, an operating agreement is one of the most critical documents for your LLC’s long-term success and legal protection.

Here, we’ll break down what an LLC operating agreement entails and why every LLC should have one in place, even single-member LLCs. We’ll also touch on what to include in this agreement and how to create one for your business.

What is an LLC Operating Agreement?

An LLC operating agreement is a written document that outlines the rules and structure of your LLC. It’s essentially the “user manual” for your company’s operations and governance. This agreement is made between the members (owners) of the LLC – or by the sole owner, if there’s just one member – and covers a variety of important topics, such as:

• Each member’s ownership stake in the business.
• How profits and losses will be distributed among members.
• The management structure of the LLC (for example, will it be managed by the members or by appointed managers?).
• Procedures for making major decisions (voting rights, what percentage is needed to approve certain actions, etc.).
• Guidelines for adding new members or what happens if a member wants to leave (buyout processes, restrictions on transfer of ownership).
• What happens if the business needs to be dissolved or wound down.

Think of the operating agreement as a contract among the LLC’s owners about how they’ll work together and how the business will operate. Once signed by all members, it’s legally binding on them, much like a partnership agreement or corporate bylaws in other types of businesses.

Why Do You Need an Operating Agreement?

Even if your state law doesn’t require an LLC to have an operating agreement, there are several compelling reasons to have one:

• Protecting Your Limited Liability: One of the reasons to form an LLC is to protect your personal assets. Having an operating agreement helps reinforce that separation. It shows that you are treating the LLC as a distinct entity and following formalities, which can be important if the legality of your LLC (and your liability protection) is ever challenged in court. For single-member LLCs, this is particularly important – the operating agreement is additional evidence that the LLC is not just an “alter ego” of the owner.
• Preventing Member Disputes: If you have more than one member, an operating agreement is crucial for preventing and resolving conflicts. By clearly laying out each person’s rights and responsibilities, everyone knows where they stand. For example, if the agreement says that major decisions require a majority vote, then one member can’t claim they alone have final say on that issue. If profits are split 60/40, it’s in writing, so there’s no confusion later. Should a disagreement arise, the operating agreement serves as the reference point to resolve it.
• Clarity in Management and Decision-Making: The operating agreement defines whether your LLC is member-managed or manager-managed. This is important operationally. In a member-managed LLC, all owners participate in day-to-day decisions. In a manager-managed LLC, you might appoint one or more managers (who could be members or outside hires) to handle daily operations, while the owners take on more of a passive, oversight role. The agreement spells out these roles, so there’s no ambiguity about who is responsible for what.
• Flexibility and Customized Rules: State default laws will govern your LLC if you don’t have an operating agreement. These default rules might not be ideal for your situation. With an operating agreement, you can customize many aspects of how your business runs, overriding the default rules as long as they’re not legally mandatory. For example, state law might say profits are split according to ownership percentage by default, but your operating agreement could stipulate a different arrangement if all members agree.
• External Requirements: Some banks and lenders want to see an operating agreement when you open a business bank account or apply for credit, especially if there are multiple owners. Investors or partners will likely ask for it too. Having one ready shows professionalism and that you have your act together as a business owner.

In summary, the operating agreement is essential because it provides a clear roadmap for how your LLC will operate and ensures that everyone’s on the same page, which can save you from legal or interpersonal problems down the line.

Key Sections to Include in an Operating Agreement

While the exact content can vary based on your business’s needs, most LLC operating agreements will cover the following key sections:

1. Organization Details: This section lists basic information like the official name of the LLC, principal office address, and sometimes the purpose of the business. It also states the formation date and which state the LLC is organized in. You might also list the members (owners) and their initial contributions (cash, property, services, etc.) here or in a separate section.
2. Membership and Ownership: Outline who the members are and what percentage of the LLC each member owns. If the ownership is divided into units or shares, that can be detailed here. For a single-member LLC, it will just confirm that you own 100% of the company.
3. Management Structure: Specify whether the LLC is member-managed or manager-managed. If manager-managed, list who the manager(s) are and what authority they have. Also clarify what decisions managers can make on their own and what decisions require member approval.
4. Voting Rights and Decision Making: Describe how voting works. Do all members have equal votes, or is voting power proportional to ownership percentage? What types of decisions require a vote, and what threshold is needed (simple majority, supermajority, unanimous consent for major changes, etc.)? For instance, admitting a new member might require unanimous approval.
5. Capital Contributions: If members are expected to contribute additional funds in the future, outline how that will work. What happens if a member doesn’t contribute as agreed? This section can also cover if and how members can withdraw equity from the company.
6. Distribution of Profits and Losses: State how profits (and losses) will be allocated among members. Often this is according to ownership percentage, but members might agree to a different split. Also, clarify the schedule for distributions (e.g., quarterly, annually, or as decided by members).
7. Compensation and Perks: If managers (or members) are entitled to a salary or guaranteed payments, include that. Also mention how business expenses will be reimbursed and any other benefits.
8. Transfer of Membership Interests: Define what happens if a member wants to sell their stake, becomes disabled, passes away, or declares bankruptcy. Many operating agreements give existing members the first right to buy out the departing member’s interest to prevent outsiders from automatically coming into the business.
9. Dissolution: Outline the conditions under which the LLC can or must be dissolved (shut down). This could be a unanimous vote to end the business, or events like the company going bankrupt. Also describe the process for winding down – how assets will be liquidated and debts paid, and how any remaining assets will be distributed to members.
10. Amendments: Specify how the operating agreement can be amended in the future. Typically, this requires a vote of the members (often unanimous or a high majority).

This list isn’t exhaustive, but it covers the main points. The operating agreement basically anticipates scenarios the business might face and sets the agreed-upon rules for handling them.

How to Create an Operating Agreement

Creating an operating agreement might sound daunting, but it’s manageable with the right approach:

• Use a Template: There are many LLC operating agreement templates available online, some even state-specific. These can provide a good starting structure. If you use one, be sure to tailor it to your business’s specific needs and double-check that it aligns with your state’s laws.
• Through an LLC Formation Service: If you formed your LLC through an online service, they often provide a basic operating agreement tailored to your information. Some services include it in their package, where you just fill in specifics. While these can be convenient, ensure you review and adjust any provisions if needed.
• Hire an Attorney: For more complex businesses or if you want peace of mind, you can have a business attorney draft an operating agreement. This ensures that the language covers all scenarios properly and is compliant with your state’s laws. The cost for this can vary, but for multi-member LLCs with a lot at stake, it might be worth the investment.
• Discuss with Co-Owners: If you have other members in your LLC, sit down together (perhaps with the draft agreement in hand) and talk through each section. It’s important everyone understands and agrees on the terms. It’s much easier to hash out differences now, before the agreement is finalized, than after an issue arises.
• Sign and Distribute Copies: Once you have a final operating agreement that all members are happy with, each member should sign it. Give a copy to every member and keep a copy with your LLC’s official records. Remember, you typically do not need to file this with the state; it’s for your internal use.

Single-Member LLCs: Yes, You Still Need One

If you’re the only owner of your LLC, you might wonder if an operating agreement is necessary. The answer is yes. Even though you won’t have disputes with other owners, the operating agreement still serves important purposes. It formally separates you from the LLC, which helps uphold the liability shield. It can detail what you’ve invested into the business and what you intend to do with profits (e.g., reinvest in the business, take distributions, etc.). Additionally, if you ever seek a loan or bring in a partner, having that operating agreement shows that you’ve treated the business professionally from the start.

Conclusion:
An LLC operating agreement might not be a public filing, but it’s a cornerstone document for your business. It establishes the rules that keep your LLC running smoothly and can save you from significant trouble down the line. Whether you have one member or many, taking the time to create a clear operating agreement is well worth the effort.

Remember, the best time to put together an operating agreement is right when you form your LLC (if not before finalizing the formation). If you’re in the process of setting up your LLC now, make sure drafting this agreement is on your checklist (our LLC Registration Process guide also reminds you to complete an operating agreement as part of establishing your LLC). If your LLC is already formed and you haven’t made an operating agreement yet, it’s not too late – gather your members and make one as soon as possible.

By having a solid operating agreement in place, you’re taking an extra step to protect your business’s future and ensure that everyone involved knows how to proceed, no matter what scenario arises. It’s an essential tool for any successful LLC.