How to Write an Operating Agreement, for Beginners
An operating agreement is a critical document for an LLC. An operating agreement defines operational and financial mechanisms for how you want your business to run. Without your own operating agreement in place, your LLC will be subject to the default rules in your state for everything from profit and loss allocation to membership value.
What an Operating Agreement Is and Why You Need One
An operating agreement is the legal document that dictates how an LLC will function. It defines who owns and manages an LLC and what their responsibilities are. An operating agreement also dictates how profits and losses are handled, and many more operational issues.
All LLCs need an operating agreement.
Operating agreements:
- Strengthen your company’s limited liability status.
- Allow you to dictate how your company is legally required to function.
- Protect members against each other from making claims of an “oral operating agreement”.
What an Operating Agreement Should Contain
Operating agreements are not all exactly the same, but they generally provide for the following:
- Ownership Percentages
List each member and define their ownership percentages. You can divide ownership based on any criteria you want. Ownership percentage is often based on how much capital investment each member makes, but it could be based on other factors, too, like work load. - Profits and Losses Sharing Policy
The sharing of profits and losses is crucial to define. Like ownership percentage, this can be based on capital invested or anything you want. - Management and Company Roles
Detail the rights and responsibilities of each member. Establish a clear management hierarchy. Will you be hiring managers or will your LLC be member managed? - Accounting and Taxes
Determine whether your LLC will be taxed as a sole proprietorship, partnership, or corporation. - Voting Rules
Determine how your LLC will make decisions. How many votes will be allocated to each member. This can be decided based on amount invested, how many hours each member has worked, or any other way you see fit. - Member Withdrawal
If a member decides to leave the LLC, what are they entitled to? - Dissolution
This will determine how remaining assets will be divided in the event the LLC is closed. It also details how and if members are allowed to continue the same or similar business in the future. - Severability Provision
A severability provision is standard for operating agreements. It just says that the entire document can’t be thrown out due to a small oversite in the document.
How to Create an Operating Agreement
Fortunately, for most small business owners, it is not necessary to write an original document. In fact, much of what is needed in an operating agreement can be found online, in free templates. Try the free operating agreement template available from Northwest Registered Agent. They have unique templates available for single-member and multi-member LLCs, as well as state-specific operating agreements. If you form your LLC with them, they’ll even complete it for free.
Operating Agreement FAQs
Can I change an operating agreement once it’s been written?
Yes, and you should include instructions in your operating agreement about how it can be amended or revoked. Otherwise you’ll be subject to your state’s default rules on how an LLC’s operating agreement may be amended or revoked.
Am I required to have an operating agreement?
Though few states require an operating agreement (only CA, NY, MO, ME, and DE do), it is crucial to have one. An operating agreement protects you and your LLC from being compromised in a lawsuit. It also helps guide your company’s management and decision making process.
What should an operating agreement include?
An operating agreement should define how you want your LLC to operated and managed. It should define your company’s ownership, profits and losses sharing, management structure and membership roles, accounting and tax structures, voting rules, membership withdrawal, dissolution, and a severability provision.
What should an operating agreement include?
An operating agreement should define how you want your LLC to operated and managed. It should define your company’s ownership, profits and losses sharing, management structure and membership roles, accounting and tax structures, voting rules, membership withdrawal, dissolution, and a severability provision.
Why create an operating agreement?
Without an operating agreement, you risk losing the limited liability status of your company. If your company loses its limited liability status, your personal assets will be at risk. An operating agreement help guide your company through future challenges. It defines how your company will be managed, your company’s voting policies for major changes, and much more.
How do you create an operating agreement?
There are lots of free operating agreement templates available online. Northwest Registered Agent offers a really good free operating agreement template.
Is an operating agreement and bylaws the same thing?
An operating agreement and bylaws are similar documents in that they are both internal governing documents, but bylaws are for corporations and an operating agreement is for an LLC.