Establishing your LLC can be an exciting affair. But before you kick up your heels and celebrate with an artisan cocktail, there are a few things you need to do first. And one of those things is coming up with an operating agreement.
An operating agreement is a legal document that establishes how your LLC will be run. It includes things like how decisions are made, how money is distributed, and how disputes are resolved.
Every member of your LLC will sign the operating agreement and, in doing so, declares that they’ll follow it closely.
Unlike your articles of organization, which you’re required to file with the government when setting up your business, an operating agreement isn’t required to form your LLC.
And, if you do choose to write this agreement, it won’t even be filed with the Secretary of State. But, even though it’s optional, an operating agreement is a critical component for any LLC with two or more members.
Keep reading for more information on the benefits of having an operating agreement in place, and how to draft one for your business.
Please keep in mind that, while we’ve made every effort to ensure this information is accurate, it should not be considered legal advice or a substitute for legal advice. Consult with your attorney if you have any questions regarding operating agreements and any other aspects of your LLC.
Why you need an LLC Operating Agreement
An operating agreement governs the relationship between the members of an LLC. For this reason, it’s a great idea to have one if your LLC will have two or more members.
If you’re planning on operating a single-member LLC, an operating agreement isn’t as important, but you may still choose to create one for yourself to outline the way that you’ll do business.
Here are a few ways that an operating agreement can help:
1. An LLC operating agreement can help protect your limited liability status
After you’ve received your limited liability status, and the protection of your personal assets that comes along with it, you won’t want to lose it. But if it appears like your LLC isn’t a legitimate business entity separate from you personally, you could lose your liability protection.
If you have a written operating agreement in place, it gives credibility to your LLC and further proves that your LLC is indeed a separate entity and not some sham created just to avoid liability.
This is especially important for single-member LLCs, which can look a lot like a sole proprietorship. The formality of an operating agreement could make all the difference in a legal dispute.
2. Lenders might want to see your operating agreement
When running a business of any kind, you might need to take out loans to cover your expenses.
But lenders, as well as other businesses you hope to work with, might want to see an LLC operating agreement before they move forward.
If you don’t have a copy of your operating agreement when you attempt to obtain a loan in your LLC’s name, you might be denied.
3. An operating agreement can override state LLC default rules
Without an operating agreement, your LLC will be solely governed by the provisions of your state’s LLC laws. And if there are any default provisions that you would prefer not to follow, you don’t really have a choice in the matter.
If you want to run your business differently, you can say so in your operating agreement, which can override some of the provisions in your state’s LLC laws.
Bear in mind that there are certain provisions that you won’t be able to override, even with an operating agreement. Check the office that governs your state’s LLC laws to learn more about what you, and can’t, override through an operating agreement.
4. An operating agreement provides a succession plan
Did you know that your operating agreement also serves as your business succession plan? It’s true.
Basically, the agreement should name someone who can manage your LLC in the event that you become incapacitated or die.
If tragedy strikes, this could make life a lot easier for your family to legally keep the business going or close it down.
5. An LLC operating agreement doubles as a useful reference guide.
Ultimately, your business’s operating agreement can be a handy guide that you refer to whenever you need to a refresher on how you should operate your LLC.
How to Create an LLC Operating Agreement
Right now, you might be thinking, “Ugh, another agreement, and more paperwork to add to the pile.” But you can relax. Creating an LLC operating agreement yourself is surprisingly easy.
One option is to hire a lawyer who can draft your operating agreement for you. Even though this is a great way to have a custom-made operating agreement, it could be pricey. Also, keep in mind that finding the right lawyer can be pretty time-consuming.
If you take this route, it’s best to hire an attorney who’s really familiar with your state’s LLC laws, and they should be able to suggest which default provisions in the law you might want to alter.
If you want something more catered to your particular needs, you can go beyond a standard operating agreement and draft your own. Or, you can just tweak a standard template, like this one that we’ve created, and customize it to better fit your business.
What Goes into an LLC Operating Agreement
Now that you know why operating agreements are so spectacularly awesome, you’re probably wondering what needs to go into an operating agreement.
The good news is that you’re free to write your operating agreement in any way that you wish. There aren’t any legal requirements regarding what you must include in the agreement.
Drafting the best operating agreement for your LLC simply means tailoring it to your business’s specific needs.
A single-member LLC’s operating agreement is usually shorter and simpler than one for a multi-member LLC since you won’t need to pay special attention to things like members’ rights and responsibilities.
Despite the freedom that comes with writing your LLC’s operating agreement, there are some key points that are worth including. At a minimum, you should discuss:
Specify if you’re the sole owner and have all the voting rights.
Make it clear that you aren’t personally liable for your LLC’s debts and liabilities (always a good idea to emphasize that point).
Establish how your LLC will be managed.
If you’re a small single-member LLC, you’ll manage it as the owner of the business.
Beyond this, determine who will take your place as the manager if you become incapacitated or die.
Keep in mind that an LLC can also be managed by a non-member manager, even though this is rare for a single-member LLC.
If you do use a manager, define that person’s rights, powers, and responsibilities in that role, and include how the manager will be appointed in the first place.
Contributions and Distributions
Specify what property, money, and/or services you’ll contribute to your business, further proving that your LLC is a legitimate entity.
Also, establish how your LLC will distribute profits or losses to you.
If you’re a single-member LLC, you’ll get 100% of both, and you’ll report it all on your personal tax return.
However, if you want to be entitled to draw from the profits of your LLC at will, say so in the agreement (this might be a good strategy if you have problems with creditors in the future).
Even if you establish your LLC with one member (a.k.a. you), you might want to let other members join the business in the future.
For this reason, it’s a good idea to have a portion of your operating agreement that’s focused on the procedures that you’ll use when admitting new members.
Set forth the general rules regarding how your LLC will be managed. Think: holding meetings, voting, documenting important decisions, etc.
Finally, don’t forget to sign your operating agreement to make it legally binding.
Remember, you don’t have to file your agreement with the Secretary of State or any other agency.
Just keep it in a safe and secure place with your other LLC records at your principal place of business.
LLC Operating Agreements: Optional but Worth It
There you have it: these are the basics that you should know about an LLC operating agreement.
Sure, it’s optional, but it’s a great little document to have in place for added protection and guidance when it comes to running your LLC like a pro.
If you’re ready to take the next step in establishing your business, join Collective and get started with everything from naming your LLC, to organizing it, and gaining access to all the necessary forms, including your operating agreement.
Once everything’s set in place, you’ll be even more prepared to make your business a success, and can finally order that seasonal cocktail that you’ve been dreaming about.
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.