What Is an Operating Agreement for an LLC, and Do You Need One?
An operating agreement outlines your limited liability company's (LLC’s) provisions, regulations, and rules. While not mandated in most states, an LLC operating agreement allows you to define each member’s role in the organization. Separate from the Articles of Organization filed with the state, every LLC should draft one, including single-member LLCs with a sole owner.
LLC owners forming a new business and existing owners who need to formalize or update their governance documents should use this guide as a high-level overview of what to include in theirs.
Key Highlights
An operating agreement outlines ownership percentages, management structure, voting rights, and how profits and losses are distributed.
California, Delaware, Maine, Missouri, and New York are among the few states that legally require LLCs to have one.
Without an operating agreement, an LLC defaults to its state's generic rules, which may not reflect what the members actually intended.
Both single-member and multi-member LLCs benefit, though multi-member agreements typically need more detailed provisions.
Banks, investors, title companies, and courts often request this agreement to confirm an LLC's legitimacy and verify its liability protection.
What is an operating agreement for an LLC?
Your LLC operating agreement serves an important purpose for your business. It outlines how the LLC will be run and each member's rights and responsibilities. It gives the owners of the LLC, known as “members,” a concrete plan for how they will operate the business together.
The agreement should include instructions for proceeding when some members are absent and the agreed-upon process for selling or terminating the LLC.
Does Your LLC Need an Operating Agreement?
Five states legally require an operating agreement, and requirements vary.
State | Requirement |
|---|---|
California | Required by law; may be oral or written, but written copies must be kept with company records. |
Delaware | Required by statute; can be oral, written, or implied, and is not filed with the state. |
Maine | Required; can be created before, during, or after formation and doesn't have to be written. |
Missouri | Required; at minimum, an oral agreement covering member and manager duties and rights. |
New York | Required in writing, adopted within 90 days of formation, kept internally and not filed with the state. |
In most states, an operating agreement isn't legally required, but banks, lenders, and investors typically request it.
If you don’t create an operating agreement, you’ll follow the default rules for LLC governance set by your state.
What to include in an LLC operating agreement
These are the key areas to address when constructing your LLC operating agreement.
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, while others are split by varying ownership percentages. Establish a foundation for your collaboration with an operating agreement that clearly defines each member’s ownership in the business.
Voting Responsibilities and Voting Rights
Your operating agreement needs to describe how business decisions will be made. What decisions can be made unilaterally, and what decisions must be voted on? For decisions that require a vote, how will voting happen, and who has the right to vote?
Many LLCs weigh votes according to business ownership, meaning members with a greater share of the company have a more significant share in the decisions.
Powers and Duties of Managers and Members
Some LLCs will select a manager to oversee operations who is not one of the company’s members, while other LLCs will be run entirely by members. Your operating agreement should clarify this and 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 business grow and adapt while avoiding issues over authority and decision-making power.
Profit and Losses Distribution
Once you’ve determined how business operations will be divided, you must define 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 another system can be put in place. This also depends on having clear and efficient bookkeeping processes for your business. You should set up specific business bank accounts to streamline the distribution of revenue and expenses.
Capital Contributions
A capital contribution is the money, property, or services a member provides in exchange for an ownership interest in the business. It directly dictates each member’s ownership percentage, profit-sharing ratio, and voting power. Cash is recorded at face value, property at fair market value, and services are detailed to determine their precise value.
Contributions should be tracked in the operating agreement's Capital Accounts section.
Meeting Rules
All members should be able to refer to the LLC operating agreement for instructions on when and how meetings will be handled. There should be rules 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.
Buyout and Buy-Sell Rules
Operating agreements should contain buyout and buy-sell agreement rules. These rules determine what happens if the LLC is sold or if a member wants to sell or transfer their stake. Do you plan on selling your company once it becomes successful? Your goals will help shape the rules.
Each member’s rights should be clearly outlined. Is any member free to sell off their ownership stake at any point? Including a right of first refusal in this section may be helpful.
Dissolution Procedures
Dissolution is the formal process of winding up the LLC's affairs, paying off creditors, and distributing remaining assets. Conditions that can trigger LLC dissolution include:
Member death, retirement, or expulsion
Deadlock
Breach of contract
Automatic dissolution
Remaining assets cannot be distributed to members until all creditor claims and liabilities have been resolved. The hierarchy for asset distribution is outlined in the operating agreement.
Single-Member vs. Multi-Member Operating Agreements
While both single-member and multi-member LLCs protect personal assets, their operating agreements serve different purposes. Single-member agreements mainly formalize the LLC's separation from its owner and support liability protection, while multi-member agreements require additional detail. Voting, profit splits, and dispute resolution should be outlined in a multi-member LLC operating agreement.
How to create an operating agreement for an LLC?
Once members have identified and agreed upon critical areas, the operating agreement should be drafted. Once approved, the operating agreement is a legal contract between LLC members, so it's essential to get it right.
Drafting Path | When It Makes Sense |
|---|---|
DIY Template | Single-member LLC owners on a tight budget and very simple business operations. |
Formation Service | Multi-member LLCs with straightforward operations who favor convenience and require a registered agent to help maintain compliance. |
Attorney-drafted | Multi-member LLCs with complex ownership structures with strict protections in place and will be raising outside capital or taking on new investors. |
A dedicated accountant or team can help align the agreement's profit and loss provisions with the LLC's tax structure and entity formation paperwork.
Benefits of having an operating agreement for an LLC
LLCs are appealing because they can be organized in almost limitless ways. This flexibility allows you to set your rules.
If you’re going to set your own rules, there needs to be clarity about what they are, which you'll outline in your operating agreement. It protects members from having to abide by default state rules and serves as guidelines for the LLC and its members.
What Happens If You Don't Have an LLC Operating Agreement?
Some states require you to submit your operating agreement before you can form your LLC. In the states that do not require an operating agreement to form, you'll have to operate under their default rules.
Creating an LLC operating agreement is a best practice whether it's required in your state or not. With an operating agreement in place, you avoid potential legal issues, sidestep management difficulties, and define how disputes are handled instead of relying on your state. Without one, courts may treat your LLC more like a sole proprietorship or general partnership, which can undermine valuable liability protection.
How to Amend Your Operating Agreement
Amending your operating agreement keeps your business legally protected and aligned with its current operations. You will need to amend yours when a new member is added, ownership changes, or for a tax election change. Here are the basic amendment process steps:
Propose the Change. Outline which sections need modification and draft the specific language you want to insert.
Hold a Member Vote. Review your current operating agreement to determine the voting requirements and officially vote on the amendment.
Draft a Written Amendment. Create a formal written document that clearly states the original section being changed along with updated text.
Sign and Date. Have the appropriate parties sign and date the amendment to make it legally binding.
Store it Securely. Attach the fully executed amendment directly to your original operating agreement and keep it with your official business records.
LLC Operating Agreement FAQs
Does an LLC operating agreement need to be notarized?
No, an LLC operating agreement does not need to be notarized to become legally binding. It is simply an internal governance document that you keep with your business records, rather than a public one. However, there are benefits. Having your agreement notarized can help establish authenticity when applying for business bank accounts.
Is an operating agreement required for an LLC?
The requirement depends entirely on the state in which your LLC is formed. While most states do not legally mandate an operating agreement, a few do. Even if your state does not require it, having one is recommended to protect your personal liability and business operations.
Is an operating agreement the same as Articles of Organization?
No, these documents serve very different purposes. Articles of Organization are a mandatory, public document filed with your state's government to create your LLC. An operating agreement is an entirely internal contract that outlines how your business will be managed, financed, and operated.
Do single-member LLCs need an operating agreement?
Most states do not explicitly require a single-member LLC to have an operating agreement. However, every LLC, including single-member LLCs, should draft one. An operating agreement is crucial to separate your personal and business liabilities in the eyes of a court. Many banks and lenders will require it before opening a business bank account or securing funding.
Can I write my own LLC operating agreement?
Yes, you can write your own LLC operating agreement. Many business owners use online operating agreement templates or legal software to draft customized documents tailored to their business structure. However, if your business has complex financial arrangements or multiple members, consulting with a business attorney is strongly advised to ensure all legal and financial matters are covered.
What happens if my LLC doesn't have an operating agreement?
Without an operating agreement, your LLC will be governed by the standard default laws of your formation state. These generic state provisions may not align with how you actually want to run your business or distribute its profits. Operating without one can also make it difficult to prove your business is a separate legal entity, potentially jeopardizing your valuable limited liability protection. "Piercing the corporate veil" is a legal doctrine that allows courts to disregard an LLC's status and hold its owners personally liable for the business's debts and liabilities.
How much does it cost to create an LLC operating agreement?
Creating an LLC operating agreement can cost anywhere from nothing to several thousand dollars depending on your situation and the route you choose. You can download and customize free templates online yourself for no cost. If you hire a lawyer to draft a highly customized agreement, you can generally expect to pay between $300 and $1,500 for their legal services.
Work With LLC Formation Experts
While LLC operating agreements are optional in most states, every business should have one. Be sure to include ownership percentages, member powers, and meeting rules in yours. Getting your agreement right the first time can be difficult without expert support.
1-800Accountant's entity formation service helps businesses officially form as LLCs, handles state paperwork, and guides the creation of your operating agreement. This allows LLC members to operate with confidence knowing that their interests are protected.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1‑800Accountant assumes no liability for actions taken in reliance upon the information contained herein.