What Is an Operating Agreement?

An operating agreement outlines the ownership and operating procedures of a limited liability company (LLC) or partnership. This document is a critical component of forming a business, sometimes required by the state during the formation process. 

What Is an LLC Operating Agreement?

An operating agreement is a document that is typically drafted after an LLC is registered with the state. The agreement outlines crucial information about the terms of the LLC such as how financial and operational decisions are to be made and procedures in case of future events. 

While most states do not require businesses to create an operating agreement, it is still an important part of the formation process, especially if the LLC has multiple owners. 

There are three different types of operating agreements depending on the type of business you’re running: single-member LLC operating agreement, multi-member LLC operating agreement, and partnership operating agreement. 

What Is Included in an Operating Agreement?

The information included in your operating agreement is essentially your business’s rules for operation. This should include details about ownership, procedures, and responsibilities. 

Sections of an operating agreement generally include: 

  1. Ownership by percentage 
  2. The LLC’s management structure 
  3. Member roles, powers, and responsibilities 
  4. Decision-making, meetings, and voting procedures 
  5. Ownership interests if member chooses to exit  
  6. Procedures in case of dissolution  

Do I Need an Operating Agreement for My LLC?

Most states don’t require you to have an operating agreement when you form an LLC. However, it is a good idea to create one regardless. 

Operating agreements not only outline general procedures and ownership percentages, they ensure all LLC members are aligned and prevent future conflict. Especially during periods of change such as when a member leaves or if the LLC is dissolved. 

Benefits of an LLC Operating Agreement

Despite operating agreements not being required in many states, there are still several benefits to draft one such as to prevent conflict or protect LLC owners. 

  • Prevents Future Conflict: By ensuring LLC members are on the same page through an agreed upon operating agreement, businesses can prevent conflict between members in the future
  • Protects Personal Assets: Separates owners from the LLC, protecting personal assets of LLC members 
  • Retains Operation Control: Establishes rules as determined by the LLC, rather than requiring the business to default to state LLC rules 

How to Write an Operating Agreement

Your LLC operating agreement will include some basic information about your business such as the address, names and information about members, purpose, and how the business is taxed. In addition to these basic inclusions, you should also complete the following steps.

Step 1: Establish Ownership Percentages 

Determine the percentage of ownership each LLC member has and include that first in your operating agreement. This section should include the names, titles, and addresses of each member in addition to their ownership percentages. You should also include details on the distribution of profits and losses depending on the percentage of ownership in the business. 

Step 2: Determine Responsibilities, Compensation, and Rights 

The second section of your operating agreement should detail your member’s voting rights, responsibilities of each member, compensation such as salaries or hourly wages, and any requirements for performance. 

Step 3: Outline Procedures for a Member Exit or Admission 

If a member chooses to leave the organization, you need to have procedures in place that outline what will happen to the member’s ownership percentage and duties upon exiting. You should also include any details about procedures when introducing a member here as well. 

Step 4: Include Procedures in Case of Dissolution

Should your LLC close its doors or dissolve, you should have clear guidelines for what happens to any company debt that remains, member responsibilities, and the division of any remaining assets. 

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Additional Tips:

  • Depending on the type of business you’re running, your operating agreement structure will vary. Be sure to follow a template or guidelines that align with your business structure. 
  • Operating agreements can be changed through a process of review, discussion, voting, documentation, and signing by all members. 
  • Operating agreements should be stored in a safe, secure place where any LLC member can access the agreement. 
  • Review your state’s requirements for operating agreements to ensure you’re forming your business correctly. 

Conclusion

An operating agreement is a helpful document for LLCs regardless of the number of owners. While not all states require operating agreements during formation, they can be a valuable tool to reduce member conflict, navigate changes within the business, and ensure all members understand their rights and responsibilities. 

FAQs

What is the purpose of an operating agreement?

An operating agreement outlines ownership percentages, operational procedures, and important information about a business. This documentation is required by some states during the formation process and can be a valuable resource for business owners to ensure all members are aligned in terms of roles, ownership, and business processes. 

Should I write my own operating agreement?

You can write your own operating agreement for your LLC. However, using an operating agreement template can make the process easier and ensure you are including all of the necessary information for an effective operating agreement. 

Is an operating agreement the same as a business plan?

No, operating agreements tend to detail the internal operations of a business and information pertinent to the business owners or members. Alternatively, business plans are more externally focused, detailing information on the target market, marketing strategies, and revenue streams.