LLC Operating Agreement
An LLC operating agreement is a legal document that delegates individual rights and responsibilities, establishes business protocol, and organizes how an LLC will operate. This document is often drafted after the LLC is formed, and must be signed by all founding members.
LLC Operating Agreements by State
Who Needs an LLC Operating Agreement?
Operating agreements are recommended for LLCs in every state, including both single and multi-member LLCs. They afford legal protections, establish guidelines for running the business, and ensure each member of the business does their part.
However, an LLC operating agreement is only required in 5 states:
- New York
What is an LLC Operating Agreement Used For?
An operating agreement is drafted and maintained by the members of an LLC – it doesn’t require filing with the state. However, it is still legally binding and the terms included in the agreement may be used during litigation to enforce responsibility upon individual members, such as in the case of a dispute within the LLC.
Additionally, an operating agreement establishes clear guidelines on how a business will run, rules that must be followed, and the exact rights and responsibilities of individual managers or members. This way everyone is clear on the same page, which helps to avoid disputes in the future.
Finally, in the case of a lawsuit against the company for damages, the establishment of an LLC and the usage of an operating agreement helps to separate the assets of the members from the assets of the company, protecting individuals from financial damages.
What’s Included in an LLC Operating Agreement?
Individual Roles & Responsibilities
Outlined in the operating agreement should be classification of each member of the LLC as well as their role within the company. This should also include a summary of their responsibilities and consequences for failing to uphold their contributions.
Based on the contributions and/or duties of the member, the ownership percentage of the LLC should be included in the operating agreement.
The agreement should outline each member’s share of the profit and loss the company generates as well as how the tax implications are distributed. This may also include if/how taxes are passed through to members.
Based on member interest and ownership percentage, the weight a member’s vote holds (including tiebreakers) should be provided in the document.
Terms for Adding or Removing Member/Manager
In the case that a new member is to be added to the company or a member is mutually removed (such as in the case of death), the voting and/or decision making process to enact this change should be outlined.
Terms for Buyout
If a member wishes to be bought out of their membership interest, the criteria for calculating the buyout and terms for buyout shall be included.
Terms for Liquidation or Dissolution
An LLC operating agreement should outline ownership of individual company assets, financial responsibilities, and the breakdown of how these duties are to be allocated in the case of closing or selling the company.
Terms for Making Changes to Operating Agreement
The needs of each business are unique, so an operating agreement may need to change as the business develops. In the case that new terms are to be added to the LLC operating agreement, the voting process and procedure for enacting the changes should be outlined in the base agreement.
Forming an LLC
Step 1 – Conduct a Name Search
All LLCs formed in the United States are required to legally register a business name for their LLC with the state of formation.
The name must be unique from government titles and all other business names in the state (both LLCs and otherwise) and should include LLC, L.L.C., or Limited Liability Company in the name to designate the formation as an LLC. It may not include designators for other business types. Certain professional LLC formations may be required to provide verification to use titles in their business name.
Each state offers a form of a “business entity search” which allows you to check your desired name’s availability with the state before filing.
Step 1a – Reserve the Name
Reserving a name is recommended for most new formations. However, in some states LLC formations are required to reserve their name before filing their formation articles. To do so, states will provide a form that reserves a name for a period of time (for a fee), which allows you to proceed through the rest of the formation process without worrying about a name denial derailing your plans.
Step 1b – Get an EIN
Most businesses will need an Employer Identification Number (EIN) to open a business bank account, but certain states require this EIN as part of the formation articles. In this case, reserving a name is highly recommended or even required so that the EIN can be acquired with the proper legal business name. If that name were to change, it would require a new EIN filing which would further delay the LLC formation process.
Step 2 – Choose a Registered Agent
Registered agents are a critical part of every LLC in the United States. An agent acts as a legal contact within the state of formation who is responsible for accepting documentation on the company’s behalf. This can be an individual or a business.
Individuals often must be 18 or older, residents of the state with a legal non-PO box address who can be reached from standard 9am-5pm business hours. They may be an LLC member, family member, professional third party, or just about anyone who accepts the legal responsibility of the position.
Registered agent services must simply be authorized to do business in the state of formation.
Step 3 – File Formation Articles
To legally establish an LLC, all LLCs must file formation articles with the state where the business is being formed. These articles may be filed online, by mail, in-person, or by fax depending on the state of formation’s Secretary of State requirements.
Domestic LLCs – businesses being formed for the first time in the United States – will often file Articles of Organization or a Certificate of Formation with the state.
Foreign LLCs – businesses expanding to the state of formation that already exist elsewhere – will usually file an Application for Registration, Statement of Foreign Entity Authority, or Foreign Registration Statement with the new state of formation. Foreign LLCs should also include a Certificate of Good Standing from the original state of formation dated within 6 months of the new filing.
Step 4 – Publish Notice of Formation in Newspaper (Some States)
In some states, new LLCs are required to publish a notice of formation in a local newspaper for between 1-4 weeks. The advertisement often must be placed in a paper within the same county as the LLC’s registered agent. Upon completing the required publication, you’ll receive an Affidavit of Publication which is required to prove that the requirement was completed in the case of an inquiry. It may or may not be required to be filed with the state depending on the state of formation.
Step 5 – Draft an LLC Operating Agreement
After going through the process of forming your LLC, you’ll be able to begin the process of drafting your operating agreement. It is recommended that the agreement is created last to ensure that all applicable information is available to complete the form and all parties are agreed upon its terms.
During formation, you chose:
- Business Name
- Business Address
- State of Filing
- Registered Agent Information
- Members of the LLC
When creating your own LLC operating agreement (or using our template), you’ll need to insert this information to help identify and classify the LLC the agreement pertains to. Then, based on the terms you or your fellow members decided on, you’ll outline the finer points relating to operation, practices, legality, applicability, and more.
Writing Your LLC Operating Agreement
Business Legal Information
The unique name chosen at the beginning of the LLC formation process should be used to declare who the operating agreement will apply to.
Date of Establishment
The date that the operating agreement will take effect, which is usually the date it is signed by all required parties.
State of Filing
Wherever the LLC is officially formed should be declared in the agreement to clarify which state laws will apply to any later terms included.
The principal office is often the main place of business, which can be a store or the home address of a single-member LLC manager.
Registered Agent Information
Selected during the formation process, the registered agent’s information should be included to specify who the legal responsibility of handling legal documentation falls on.
If the business has a clear and defined purpose, it may be stated. However, it is assumed that the purpose of LLCs who aren’t declared as nonprofits is to sell a product or services.
Duration of Business
An LLC operating agreement should include the duration of which the business will operate, which is often in perpetuity until dissolved or withdrawn, to ensure that the agreement is enforceable throughout the life of the company.
Legal Power Applicability
While it may seem redundant, the declaration that the company has the power to pursue the requirements for achieving the purpose of the business, which includes completing sales, banking, and more.
Place, Time, and Frequency of Meetings
In a multi-member LLC, meetings are essential as a way for motions to be voted on by the members. If there is to be a yearly meeting, the terms (time, date, and location) for this meeting should be included to set expectations for attending, or allow for waiver of notice.
Waiver of Notice
Decisions relating to the business require a majority of the members to be included, unless a waiver of notice is provided to omit the member from consideration of the meeting. The requirements for waiver of notice to be acknowledged should be outlined to ensure that quorum can be reached and that all parties may be involved.
Action Without Meeting
If a vote is unanimous, this section may allow the motion to pass without requiring a meeting when there are a majority of votes recorded in writing.
Requirements for a Quorum
The operating agreement may specify the percentage of ownership that must be represented in a meeting to constitute a quorum, which would be required for a legal vote, in other sections.
Voting Terms and Requirements
The operating agreement may determine what percentage of votes are required for a motion to pass (usually 51%) as well as how members may vote (in-person or by proxy).
Officers can be members or non-members who represent the members in conducting business on behalf of the company. Within an operating agreement, the positions of officer, their powers, and rules regarding their appointment or removal may be specified.
Adding a Member
To enable adding a new member to an existing LLC, the operating agreement should specify the required vote or other terms for addition to be legal.
Removing a Member
The terms for removal of a member should be specified in the operating agreement so that all members know what is not allowed. This can include both why a member may be removed, the vote required to enact the removal, and how the member’s ownership is to be managed (redistributed, sold for a specific value, or otherwise).
Membership Interest and Contributions
Each member of an LLC may own a certain percentage of interest in the company. This amount can be reflective of the contributions made (financial, physical, services or otherwise), and any financial considerations should be recorded in the case that the contribution is to be repaid according to the agreement.
Assigning Membership Interest and Obligations
An operating agreement can include specific obligations that different classifications of members are bound to. It should also disclose the exact ownership percentage of each member.
Profit and Loss Distribution
Depending on ownership percentage, contributions, or other terms specified in the operating agreement, the terms used to determine how any profit or loss is distributed amongst members may be outlined. This may be based on ownership percentage, a specific percentage to pay back initial contributions, the source of income, or any other terms outlined in this section.
Terms for Maintaining and Providing Financial Records
Recordkeeping is an important part of any business, and with the operating agreement, the obligation may be designated to an individual member or the cost of doing so may be declared a company expense and paid for by the members.
Obligation to Furnish Financial information for Tax Returns
Each business is expected to file a tax return with the federal government (and in many cases, the state) for each year of business. The physical and financial responsibility of organizing and filing taxes may be allocated within the LLC operating agreement to a member or the company as a whole.
Ending a Business
Criteria and Procedure for Dissolution
The criteria that must be met for a dissolution as well as how company assets are to be distributed should be included in the operating agreement in the case that the business closes or is dissolved.
Certificate of Termination
When an LLC is being terminated, the final requirement may be a Certificate of Termination, which officially causes the company to end. This section should be included to ensure that a dissolved or withdrawn LLC can be legally terminated by its member(s).
Indemnification of Personal Liability/Separation of Assets
An important benefit of operating as an LLC is the ability to separate business and personal assets, which can be done with a statement of indemnification. In the case of legal action being taken against the company, the damages are limited to the company assets instead of the members’ personal assets.
A statement on applicable law determines which jurisdiction the company is governed under, inheriting all state laws that guide the operation of the company.
In the case that any provisions within the operating agreement are nullified, a severability clause ensures that all other terms are still valid.
With their legal signature, the binding effect provision provides the signer’s written consent to entering the legally-binding agreement.
Written Consent from All Members
All LLC operating agreements should be signed by the members of the LLC to ensure that everyone is on the same page and that each member is legally binded to adhere to the terms within the agreement.