Operating Agreement: Why Every LLC Needs One

An Operating Agreement is the internal rulebook for your LLC. It defines ownership, management, and how the business operates. Every LLC should have one.

What Is an Operating Agreement?

An Operating Agreement is a legal document that outlines how your LLC is owned and operated. Unlike Articles of Organization (which are filed with the state), the Operating Agreement is an internal document kept with your business records.

Think of it as your LLC's constitution. It covers:

• Who owns the LLC and in what percentages
• How profits and losses are divided
• Who can make decisions and how
• What happens if a member wants to leave
• How the LLC can be dissolved

Why You Need One

Even though most states don't require an Operating Agreement, every LLC should have one for these reasons:

1. Banks Require It

Most banks won't open a business account without an Operating Agreement. It proves who owns and can act on behalf of the LLC.

2. Protects Your Liability Protection

An Operating Agreement helps demonstrate that your LLC is a legitimate separate entity from you personally. Without one, courts might question whether your LLC is truly separate, weakening your liability protection.

3. Prevents State Default Rules

Without an Operating Agreement, your state's default LLC laws govern your business. These one-size-fits-all rules may not match how you want to operate. For example, some states default to equal profit sharing regardless of capital contributions.

4. Prevents Disputes

Clear written agreements prevent misunderstandings. If disagreements arise, your Operating Agreement provides the answer.

5. Legal Requirements (Some States)

California, New York, Missouri, and Maine legally require LLCs to have Operating Agreements.

Key Provisions to Include

Ownership and Capital Contributions

Document each member's ownership percentage and what they contributed (cash, property, services) to the LLC.

Profit and Loss Distribution

Specify how profits and losses are allocated. This can be proportional to ownership or based on other arrangements. LLCs have flexibility here that corporations don't.

Management Structure

Define whether the LLC is member-managed or manager-managed. Specify who has authority to:

• Sign contracts
• Open bank accounts
• Hire employees
• Make major business decisions

Voting Rights

Outline how decisions are made. Common approaches:

• Unanimous consent for major decisions
• Majority vote for routine matters
• Different voting thresholds for different types of decisions

Meetings and Records

Specify meeting requirements and record-keeping procedures. Even if you're a single-member LLC, documenting major decisions protects your liability shield.

Transfer of Membership

Address what happens if a member wants to sell their interest:

• Can interests be freely transferred?
• Do other members have right of first refusal?
• What's the process for valuing membership interests?

Dissolution

Define when and how the LLC can be dissolved and how remaining assets are distributed.

Operating Agreements for Single-Member LLCs

"I'm the only owner. Do I really need one?"

Yes. Here's why:

• Banks require it to open accounts
• Liability protection is strengthened by showing your LLC operates as a separate entity
• Future-proofing makes adding members later much easier
• Professionalism is demonstrated to clients and partners

Single-member Operating Agreements are simpler than multi-member versions but should still cover the basics: ownership, management authority, and dissolution procedures.

Operating Agreements for Multi-Member LLCs

When you have multiple owners, your Operating Agreement becomes critical. Additional provisions to include:

• Capital calls: Can members be required to contribute more capital?
• Buyout provisions: What happens if a member dies, becomes disabled, or wants out?
• Non-compete clauses: Can members start competing businesses?
• Deadlock resolution: How are ties broken in voting?
• Dispute resolution: Mediation, arbitration, or litigation?

How to Create an Operating Agreement

You have several options:

Formation Service

Services like StartGlobal include Operating Agreements customized for your state and situation. This is the best balance of quality and cost for most LLCs.

Online Templates

Free or low-cost templates are available online. Be cautious: generic templates may not comply with your state's laws or fit your needs.

Attorney

For complex multi-member LLCs or high-value businesses, hiring an attorney to draft a custom agreement provides the most protection.

Frequently Asked Questions