An LLC Operating Agreement is a legal document that outlines the ownership and member duties of your Limited Liability Company (“LLC”).
This agreement allows you to set out the financial and working relations among business owners (“members”) and between members and managers.
An LLC operating agreement customizes the terms of an LLC according to the specific needs of its owners. It also outlines the financial and functional decision-making in a structured manner. It is similar to Articles of Incorporation that govern the operations of a corporation. To take full advantage of having an LLC, you should go one step further and write an operating agreement during the startup process. Many tend to overlook this crucial document since it is not a mandatory requirement in most LLC jurisdictions; it is nonetheless considered a crucial document that should be included when setting up a limited liability company.
The operating agreement is thus a document which spells out the terms of a limited liability company (LLC) according to the members. It sets forth the path for the business to follow and brings in more clarity in operations and management. An LLC operating agreement is a 10- to 20-page contract document which sets up guidelines and rules for an LLC.
The document, once signed by each member (owners), acts as a binding set of rules for them to adhere. The document is drafted to allow owners to govern the internal operations according to their own rules and specifications. The absence of this document means that your business has to be run according to the default rules of the LLC Jurisdiction.
Even if an Operating Agreement is not required in your preferred LLC jurisdiction, it is strongly recommended to have one:
• If you have business partners (Multi-Member LLC):
An operating agreement will help prevent misunderstandings by setting clear expectations about partner roles and responsibilities.
• If you are the sole owner of an LLC (Single Member LLC):
Creating an operating agreement brings credibility to your LLC. This helps to ensure courts uphold limited liability status of your LLC.
The form and contents of operating agreements vary widely, but typically an Operating Agreement will typically cover 7 areas/topics: Organization, Management and Voting, Capital Contributions, Distributions, Membership Changes, and Dissolution.
Article I: Organization
The first section of the operating agreement deals with the creation of the company. It covers when the company is created, who the members are, and the structure of ownership. If there are multiple members, they may all have equal ownership or different amounts of “units” of ownership.
Article II: Management and Voting
This section addresses how the company is managed and how the members vote.
• The company may be managed by the members or by one or managers that are appointed by the members, and the operating agreement specifies what authority the members or more have over company affairs.
• The company may choose to make decisions though a voting process. Votes may be allocated among the members in any number of ways, including one vote per member, one vote per unit of ownership interest (if the company ownership is described in terms of units), etc. The operating agreement may specify what amount of votes is required for particular actions by the company.
Article III: Capital Contributions
This section covers which members have given money to start the LLC. It also discusses how additional money will be raised by members. For example, an LLC can choose to issue ownership “units” in exchange for money.
Article IV: Distributions
This section provides how the company’s profits and losses are shared among members. This might include money, physical property, or other business assets.
Article V: Membership Changes
This section describes the process for adding or removing members. It also states if and when members can transfer their ownership of the company. For example, the company will want to specify what happens if a member dies, a member goes bankrupt, two members divorce, etc.
Article VI: Dissolution
This section of the operating agreement will explain the circumstances in which the company may be or must be dissolved. This is sometimes called “winding up” the affairs of the company.
Other Topics
In addition to these six key sections, operating agreements may address any number of other topics. This depends on circumstances of a particular company. For example, members may wish to include requirements for periodic meetings, restrictions on check signing, or explain how disputes within the company will be handled. Keep in mind that your operating agreement can be updated at any time through a process of your choice.
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