A limited liability company is a flexible business entity that can protect your individual assets without sacrificing your control over the organization. It’s a popular kind of legal structure to consider when you’re starting a business. However, the first thing to know about starting an LLC is that you’ll need to put together an operating agreement before formally starting your business.
What Is an Operating Agreement?
An operating agreement is one of the most important parts of an LLC, and it’s often essential before you can form an LLC. If you are planning to write an Operating Agreement, you’ll need to know what to include, why they’re important, and if every state requires one.
LLC Operating Agreements may not seem important at first, but they serve important purposes. It’s a document that outlines how the LLC will be run and what the rights and responsibilities of each member are. It gives the owners of the LLC, otherwise known as the “members” of the LLC, a concrete plan for how they will operate the business together.
Members can find what they contain to be very useful during meetings and voting procedures. The agreement should include instructions for how to proceed when some members are not present, as well as the agreed-upon process for selling or terminating the limited liability company as a business.
How Do Operating Agreements Work?
Limited liability companies are very flexible business entities, and they can be organized in almost unlimited ways. You can set your own rules for running the company and determining who has what authority.
If you’re going to set your own rules, however, there needs to be clarity about what those rules are. The operating agreement is the contract among LLC members establishing the basic rules you’re going to follow. It should serve as a set of guidelines for an LLC and its members.
These agreements should provide information regarding members’ duties, rights, and roles. Operating agreements should also detail what happens in circumstances such as if a member leaves or if the LLC is sold.
Does My LLC Need an Operating Agreement?
In some states, you won’t need an Operating Agreement to start your LLC, but LLC members can still benefit from having one completed. Other states may require you to submit your operating agreement shortly before or after filing your official articles of organization.
If you don’t create an operating agreement, you’ll be following the default rules for LLC governance set by your state. Before you form your business, you should make sure you’re fully informed about the rules you’ll be expected to comply with.
A formal operating agreement may be more helpful for a multi-member LLC than a single-member LLC, as a single-member LLC won’t have any confusion about splitting up benefits or duties among members.
Why Are Operating Agreements Important?
Operating agreements are important because they outline an LLC’s provisions, regulations, and rules. It’s also important so that members of the LLC can all know how the business is supposed to function. While a single-member LLC is similar to a sole proprietorship in that one person is essentially responsible for everything, that’s not true for most LLCs.
For LLCs in real estate and other similar industries, an LLC operating agreement allows you to clearly define each member’s role in the organization. This can be helpful, even if your state doesn’t require an operating agreement.
What Is Included in an LLC Operating Agreement?
There’s a lot you need to know about your business plan before you can complete your operating agreement. Your operating agreement includes a lot of different important processes and issues you might not have considered, so you should take your time putting it together. Here are some key things to include:
1. Member Ownership Percentage
What percentage of the business does each member own? How will the stocks be divided? Some multi-member LLCs will split everything evenly among members, but that’s often not the case. You want to establish clear foundations for your collaboration with an operating agreement including each member’s ownership percentage.
2. Voting Responsibilities and Voting Rights
Operating agreements need to describe how business decisions will be made. What decisions can be made unilaterally, and what decisions have to be voted on? For decisions that require a vote, how will the voting happen, and who has the right to make a vote?
Many LLCs weigh votes according to business ownership. That means members with a greater share of the company have a greater share in the decisions.
3. Powers and Duties of Managers and Members
Some LLCs will select a manager to oversee operations who is not one of the actual business owners or members of the company, while other LLCs will be run entirely by members. Your operating agreement should make this clear. It should specify both the authority and the expectations of each manager and member.
What do each manager and member have the power to do, and what are their responsibilities to the company? Clearly, defining each individual’s role and capacity will help your company grow and adapt without unnecessary struggles over authority and decision-making.
4. Profit and Losses Distribution
Once you’ve figured out how business operations will be divided, you also need to figure out how the resulting profits and losses will be handled. Your operating agreement should include details about how profits and losses will be dispersed to members.
Profit and loss distribution can be determined based on each member’s ownership percentage, or there can be some other system. This also depends on having clear and efficient bookkeeping processes for your business. You should have specific business bank accounts set up to streamline the process for efficient distribution of revenue and expenses.
5. Meeting Rules
All members should be able to look to the LLC operating agreement for instructions on when and how meetings will be handled. There should be rules provided regarding who can hold meetings, who will take minutes, and who sets the meeting agenda.
Not every state requires official member meetings or predesignated rules for those meetings. If you’re going without an operating agreement, you’ll also need to be familiar with your state’s default rules for LLC meetings and governance.
6. Buyout and Buy-Sell Rules
Operating Agreements should also contain buyout and buy-sell rules. This will determine what will happen if the LLC is sold or if a member wants to sell or transfer their stake in the LLC. Do you plan on selling your company once it becomes successful?
Each member’s rights should be clearly outlined. Is any member free to sell off their ownership stake at any point? It may be helpful to include a right of first refusal in this section of the operating agreement.
Get Help From the Professionals
A lot goes into an LLC operating agreement, and it’s difficult to change once it’s been made official. You want to be careful what you commit to when organizing your business. Before finalizing anything, discuss your operating agreement with the professionals.
Working with an accountant can help you improve your overall business plan and set your LLC up to be more efficient. You should also consult with a law firm to make sure you’re as informed as possible about any liabilities and limitations that come with your commitment to this operating agreement.