What Is an Operating Agreement?
An operating agreement is a document that outlines an LLC’s rules and regulations.
It functions similarly to articles of corporation, which are used to govern corporations.
How an Operating Agreement Works
An operating agreement establishes the LLC as a separate corporate entity from its individual members, allowing that organization to take advantage of the limited liability protection of an LLC.
Without an operating agreement, that LLC would be subject to whatever default stat rules are in place and its members would not receive the above-mentioned protection.
While an operating agreement is required in most cases, in some states such as New York, they require you to register an operating agreement upon the LLCs creation.
As for the structure of the document, an operating agreement is typically about 10-20 pages and includes guidelines and rules for the LLC to follow.
That typically includes:
Ownership percentages for each member
Distribution of profits and losses
Management structure
Operating procedure
Meeting provisions
Liability statement
Tax treatment
Voting rights
And more
What Are the Benefits of an Operating Agreement
An operating agreement “activates” the various protections provided by the limited liability company framework, including pass-through taxation.
Without an operating agreement in place, you’re subject to your state’s general rules which often don’t provide the specific regulations and protections you need or want.
With that said, let’s dive quickly into the specific benefits of an operating agreement:
(Limited) Liability protection
An LLC provides limited liability protection, but only if you have an operating agreement in place.
Without being recognized as a separate legal entity, you could be held personally responsible for the financial loss incurred by lawsuits and debt collection among other things.
Avoid general state guidelines
As we touched on, your state’s default rules likely won’t favor you and your business.
Typically, they more closely align with those of a sole proprietorship, meaning you’ll lose out on key protections and other benefits.
Run your LLC the way you want
On the flip side, with an operating agreement in place, you can structure your organization the way you want.
Establish the ideal profit split, delineate responsibilities in a unique way, and more.
An operating agreement is more than just a document you need to run an LLC, it’s a document you can use to set your organization up for success.
How to Know If Your Need an Operating Agreement for Your LLC
An operating agreement isn’t required in most states. However, some do, and typically upon the initial startup phase and registration of the LLC.
Those states include:
New York
Maine
Delaware
Missouri
California
Remember not to view an operating agreement as a necessary, useless document simply required or recommended.
An operating agreement is a useful document that allows you to establish your organization with the rules and regulations that you want to put in place.
This gives everyone in the organization clarity about how the company is going to operate, making it easier to keep everyone on the same page and avoid issues down the line.
A note on single-member LLCs: Should you use an operating agreement?
Yes, a single-member LLC should use an operating agreement. If you’re just starting out, chances are you don’t see a need for an operating agreement.
However, in time, your company will grow and a pre-established operating agreement will help avoid future problems when your team expands to more than just you.
This also helps you immediately establish the proper liability protection inherent in all LLCs, whether it’s just you or a team of members.
How to Set Up Your Operating Agreement
Now, let’s cover how to put together your operating agreement.
Creating your operating agreement just takes a few straightforward steps:
1. Collect essential information on your LLC
An LLC mostly includes essential information, such as:
Number of members (owners)
Ownership percentages
Management structure
And operating procedure
This is all information you’ll need to decide on and gather ahead of time to include in your operating agreement.
2. Gather information on your state and local laws
Depending on what state you’re in, certain state and local laws may apply to and affect your operating agreement.
Learn what those are so that you can craft your operating agreement in a way that they adhere to them.
3. State on your organizational structure
Next, you’ll want to record your organizational structure, which includes procedures as well as management structure.
This should also mention membership percentages and who has what specific responsibilities.
4. List any additional provisions
Lastly, you’ll need to list out any additional provisions that apply to the organization. That can include:
Profit distribution
Meeting provisions
Member provisions (hiring, removing or adding members, etc)
Tax treatment
Voting rights
Also, make sure to include a liability statement to enforce limited liability protections.
5. Sign, date and store
Finally, it’s time to finish your agreement by obtaining signatures from every owner and providing copies to each member and internally for the organization.
LLC Operating Agreement Template
If you’re ready to craft your operating agreement, we’ve taken the next step and provided a link to a free LLC operating agreement template (via eForm, no affiliation) you can download and plug your information into.
The template has filled in the agreement with general information applicable to most LLCs.
You can take the agreement and fully modify it to fit your organization and its needs, but this will offer a great starting point.
Your operating agreement can be modified over time, it isn’t a concrete document.
The only required portions of the agreement are on the first two pages, primarily member information:
As well as each member’s signatures at the bottom of the agreement:
You can download a free operating agreement template by clicking here: free LLC operating agreement template.
