An operating agreement is an important internal document that provides information about how a limited liability company (LLC) should run, as well as describing ownership percentages and the responsibilities of LLC members. This legal document serves as an agreement between members of multimember LLCs to define the working relationships between the members and managers. If you’re going to file an operating agreement, it should be drafted as part of the LLC formation process.
LLC operating agreements are such important legal documents that every limited liability company should have one, even if your state laws don’t require them. I’ll tell you everything you need to know about LLC operating agreements in this article, including what an operating agreement should include, how it works, and more.
What’s in an LLC Operating Agreement?
An LLC operating agreement can vary depending on the state laws where you conduct business, whether you have a single-member LLC or a multimember LLC, and other factors determined by your business industry. However, here are the six sections, or articles, that are standard in most LLC operating agreements:
Article I: Organization
The first section of your LLC operating agreement addresses various aspects involved with creating a limited liability company. It includes information about your business, such as when the LLC was formed, a list of initial members, and a defined structure for company ownership.
If you run a member-managed LLC with multiple members rather than only one member, you have the choice to give each member an equal ownership percentage, or divvy out different “units” of ownership to them.
Article II: Management and voting
This section of the LLC operating agreement determines how your business is managed, and how LLC members should vote.
You have lots of management options. You can choose to have a single-member LLC that is managed by a single member, a multimember LLC that’s managed by several members who vote on decisions, or by a group of third-party managers instead of LLC members.
The LLC operating agreement is important in this regard because it specifies which members have the authority to make financial decisions for your business.
You can use this section of your LLC operating agreement to specify which members have voting rights and how they conduct the voting process. You can give members votes based on the number of shares they have, or give each member one vote.
You can also specify in this section of the LLC operating agreement how many votes it should take for members to take certain actions for your business, such as making changes to internal operations.
Article III: Capital contributions
This section of the LLC operating agreement outlines which members have provided capital contributions (or provided funding) to start the LLC, as well as additional contributions in the future.
This section of the operating agreement should also include instructions that describe how the business will continue to raise funds. For example, you can provide members with ownership interest in exchange for monetary contributions to the business.
Article IV: Distributions
In this section of the LLC operating agreement you’ll specify the percentages of profits and losses allotted to each member. The assets you can divide between members can include things like money, physical property, and any other business assets you may have.
Article V: Membership changes
You’ll spell out what happens when there are changes to LLC membership in this section of the LLC operating agreement. It will specify what happens to existing members when new members join, if a member dies, or if a member leaves. It should specify the changes in ownership percentages that occur in such cases, or if other members buy more shares. It’s also important to point out what happens if members in relationships break up or get divorced.
Article VI: Dissolution
This section of the LLC operating agreement involves describing how the company should dissolve its LLC status. Sometimes LLCs aren’t permanent, but rather give business owners personal liability protection to guard their personal assets and enjoy tax benefits like pass-through taxation while they’re still learning about their business and how to run it.
Even if you don’t think you’ll want to dissolve your LLC, you should still include this section in your operating agreement so that there’s a contingency plan in place for dissolution. In business law this is often referred to as “winding up” the affairs of your business entity.
Other topics
Like most legal documents, you can add numerous sections to your LLC operating agreement that I didn’t list here. Additional operating agreement sections depend on things like state law requirements and the nature of your legal business entity. You can add sections that dictate how to handle internal disputes in your business, how and when to sign checks, and who should take part in periodic meetings between LLC members. You may choose to add special agreements to your operating agreement, such as a noncompete agreement. Single-member LLCs could also benefit from different sections.
Your LLC operating agreement isn’t set in stone, either. After you’ve started your small business according to your initial business plan, you can update your operating agreement as your business evolves or if your business purpose or business name changes in the future. Even though your LLC operating agreement is a legally binding written agreement, it can evolve and change along with your small business.
Do I Need an Operating Agreement?
Is an operating agreement required for your LLC? It depends on where your business operates. LLC operating agreements are legally required in California, Delaware, Maine, Missouri, Nebraska, and New York.
Even if the legal requirements for your state don’t explicitly state that you need an operating agreement, many business advisors recommend that you draft one anyway if you meet the following circumstances:
You have business partners (multimember LLC)
An LLC operating agreement can help small businesses with multiple members by clearly defining the roles of members and their financial compensation and contributions to the company.
You are the sole owner (single-member LLC)
Sole owners of LLCs draft operating agreements to give their businesses more credibility. This protects business owners in legal matters because it helps to uphold the limited liability status of their business, and it helps to ensure that the owner isn’t personally liable for the business.
After You Create Your Operating Agreement
You don’t need to file your operating agreement with the government after you’ve drafted it. Some states require you to publish your initial report or your Articles of Organization when you form your LLC. Typically you can find the requirements to form an LLC on the Secretary of State’s website.
You do need to keep a copy of your operating agreement with your other important business documents. And it’s a good idea to provide each LLC member with a copy of the operating agreement.
Any time your business undergoes a major change, you should consider updating your operating agreement. These changes may include members leaving or the addition of new members. In those cases, you can always update your operating agreement, so long as all your LLC members are in agreement to the amendments made to the document.
Drafting an operating agreement and filing your Articles of Organization are just a couple of the activities you’ll need to complete when you form your LLC. Here are a few other activities you need to take part in, as well.
Obtain an EIN
If you plan to hire employees for your business or open a bank account, you need an EIN (employer identification number). This is a business identification number used by the Internal Revenue Service (IRS).
Open a business bank account
It’s important to keep your business and personal finances separate, so opening a bank account that’s dedicated to your business transactions is a crucial part of owning an LLC. This protects your personal assets in the event that your company is sued.
Register for state taxes
Not every state requires LLCs to pay state taxes. However, many do and it depends on a number of factors, including whether you sell products. If your business qualifies to pay sales taxes, you’ll need to register with the state(s) you conduct business in. If you hire employees then you’ll need to register for things like employee withholding tax and unemployment insurance tax.
Set up a business financial system
Whether you hire an accountant to handle the financial aspects of your business or you handle the finances yourself, this is a vital decision for your company that ranks as high as choosing a business attorney. It’s important for someone to keep track of the income, expenses, and bills for your business.
Get licenses and permits
Depending on where you conduct business, you may be required to obtain business licenses and permits from both state and local governments, depending on the type of business you conduct. So check with your state and local officials to find out about license and permit requirements in your area.
Get business insurance
No matter what sort of business you run, nearly any sort of business could benefit from insurance. Whether it’s workers’ compensation, general liability, or a business owner’s insurance policy, insurance is the best way to ensure that your business assets are protected.
Operating Agreement FAQs
Do you need an operating agreement?
Unless you live in one of the states that require an LLC to have an operating agreement, nothing requires you to have an operating agreement.
However, if you don’t draft your own operating agreement, you’ll likely be stuck with the state’s default rules for LLCs, which is a sort of generalized operating agreement. While this protects you legally, you may decide that you don’t like the default rules.
It’s also worth stating that operating agreements are a more substantial way to make an agreement between your business partners than other methods, such as verbal agreements, and they’re more easily upheld in a court setting.
Do single-member LLCs need operating agreements?
You’re only required to create an operating agreement if you conduct business in one of the six states that require LLCs to draft and file operating agreements. In these states, they require single-member LLCs to draft operating agreements even though single-member LLCs typically have simple structures. However, there are several situations in which single-member LLCs can benefit from having operating agreements. So, it’s worth taking the time to create one.
How do I write an operating agreement?
There are several ways you can ensure that your operating agreement meets the legal requirements of your state, while also setting up the guidelines for business operation and the management instructions for your business.
Many LLC formation services will create an operating agreement as part of their formation services. For more information about LLC formation services, check out my article about the best LLC services, and if you’d like to know more about LLC formation, check out my article about how to start an LLC.
Other options include hiring an online legal service to help ensure that your operating agreement is legally enforceable and to help with the wording. Finally, if you’d like to draft the document yourself, you can get a free LLC operating agreement from Northwest Registered Agent here.
How much does an operating agreement cost?
If you use the free LLC operating agreement template from Northwest Registered Agent, you won’t incur any fees to write your own operating agreement. However, if you turn to an LLC formation service to draft your agreement, it can run you between $500–$1,000. But according to my research, the average cost of an operating agreement is around $600.
Who should sign the operating agreement?
Every LLC member should sign the operating agreement, as well as the managers (or manager). Every person that signs the operating agreement should also sign separate signature pages. Make sure that you check out your state’s requirements for signing operating agreements, which you can find in their LLC formation requirements. Ensuring that your operating agreement is properly signed and filed will give your LLC an extra layer of legal protection.
Is there a difference between bylaws and an operating agreement?
Yes. Bylaws are an internal document created to establish business operation and management instructions. An operating agreement is also an internal document that establishes rules about how the business should run and the managerial roles of each LLC member or manager. Those sound really similar, so what’s the difference? The main difference between bylaws and operating agreements is that bylaws apply to corporations, while operating agreements are specifically for LLCs.
What do you do with your operating agreement once you’ve drafted it?
Very few states require you to create an LLC, and even those states don’t typically specify what you must do with it once you’ve created it. So, it’s up to you what you do with your operating agreement. However, it’s advised that you file it with your other LLC formation documents. You’ll likely refer to this document often during your first year of business, so you want to be able to access it.
Does my operating agreement need to be notarized?
No requirements state that you must get your operating agreement notarized. The agreement is already considered legally enforceable without notarization. Nonetheless, many business owners decide to get a notary’s signature on their operating agreements.
Is an operating agreement required to open a bank account?
This is a complicated question. Simply stated, it depends on both the bank’s policies and your state requirements. But generally speaking, it’s a good idea to have an operating agreement on hand before you open a bank account.
