Being a startup founder requires wearing many hats. You need to be a strategist, product developer, salesperson, fundraiser, financial manager, HR and team leader…the list goes on.
A legal advisor is yet another role to add to that list. For example, if you have an LLC, you might need to draft an operating agreement, depending on the state you do business in.
In this article, we’ll go over what an LLC operating agreement is, why you need one, and how to create one for your LLC.
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What is an LLC Operating Agreement?
An LLC operating agreement is a legally binding document that defines how you’ll manage your business, make decisions, and make financial arrangements within your LLC.
It acts as a blueprint for how you’ll run your business, detailing everything from member roles to profit distribution.
State law usually does not require an LLC operating agreement. Only five states require an LLC to have one:
- California
- Delaware
- New York
- Missouri
- Maine
Why Your Startup Needs an LLC Operating Agreement
So, if most states don’t require LLCs to have operating agreements in place, why should your startup have one?
An operating agreement can protect your LLC’s limited liability status by demonstrating that the LLC is a separate entity with distinct rules and procedures.
Having an LLC operating agreement also helps you establish clear guidelines from the outset, prevents disputes, and ensures that all members are on the same page.
For example, let’s say you decide to create an LLC for a small business with two colleagues. And let’s imagine that you don’t put an operating agreement in place.
But you do verbally agree that no member should have the right to sell or transfer their interest in the LLC. That means if someone dies or no longer wants to be part of the LLC, the remaining members would re-divide the former member’s interest instead of giving it to someone new.
This might sound good, but the default laws in your state allow LLC members to transfer their interests without restrictions.
That means if one of your LLC members ever decides to sell their interest, the default laws would likely allow it.
Why?
Because you don’t have an operating agreement that outlines your preferences regarding the transfer of ownership.
On the other hand, if you had an operating agreement, you and the other remaining members of the LLC could stop the other members from selling their interests.
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Main Components of an LLC Operating Agreement
An LLC operating agreement has a few key components:
- Ownership structure: Outlines who the members of the LLC are and their stake in the company (ownership percentages).
- Member roles: Defines the roles and responsibilities of each member (e.g., authority to make decisions, manage daily operations).
- Management structure: States whether the LLC is member-managed or manager-managed.
- Decision-making: Details how you’ll make decisions and what types of decisions members or managers will make unilaterally.
- Voting rights: Determines how you’ll allocate votes within the LLC as well as the procedures for resolving deadlocks.
- Profit and loss distribution: Specifies how you’ll distribute profits and losses among members.
- Capital contributions: Details the initial contributions each member will make, whether in cash, property, or services.
- Transfer of membership interests: Specifies the rules for transferring ownership interests and any transfer restrictions, such as requiring approval from other members.
- Dissolution and liquidation: Details the circumstances under which members will dissolve the LLC, the process for winding up the business, and how members will distribute the remaining assets.
- Amendments to the agreement: Includes a procedure for making changes to the agreement, such as requiring a vote from a certain percentage of members.
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How to Create an Operating Agreement
Determine Your Needs
Assess your LLC’s structure. How many members are in your LLC? How complex are your business operations? How do you plan to manage the LLC?
Answer these questions to help you determine your management style, types of capital contributions, and profit distribution. To further protect your LLC and its members, consider using resources that provide insights into potential risks such as identity theft, data breaches, and other security concerns that can affect your business operations.
Define Key Sections
Determine the key sections you want to include in your LLC operating agreement. Some important sections are management structure, decision-making authority, and voting rights and decision-making.
Because 60% of business owners need help to keep up with compliance and regulations, it might be best to consult with an attorney who specializes in LLCs. Share the details about your LLC’s management structure, ownership, and business goals. From there, the attorney will create a customized operating agreement for your review.
You could also look for an online template that is in line with your state’s laws. Modify the template to reflect your LLC’s unique structure and operational details.
Collaborate with Members
After drafting the operating agreement, share a copy of it with all LLC members. Hold a meeting to discuss the document. Use this time to go over each section, clarify any uncertainties, and gather feedback from all members.
After the meeting, revise the draft using the feedback you received. Document all agreed-upon changes.
Once you’ve made all the necessary revisions, show the final version of the operating agreement to your team. Confirm that everyone is in agreement before proceeding to the signing stage.
Finalize the Agreement
Ensure the final document is complete, accurate, and ready for signing. Double-check that you’ve included all necessary sections and that there are no discrepancies.
If you didn’t initially work with an attorney, consider having one review the final draft to make sure it meets legal standards and protects your LLC’s interests.
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Key Takeaways for Drafting an LLC Operating Agreement
Creating an LLC operating agreement is a great way to lay a foundation for your company’s governance, decision-making processes, and financial management,
While this document serves as a legal requirement in some states, it’s an important tool for ensuring clarity and alignment among your LLC members.
Taking your time to craft an operating agreement can help you protect your interests and set the stage for sustainable business growth.
Image by Tumisu from Pixabay
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Corporations Today decodes the complexities of the Corporate Transparency Act, providing vital services to keep your business compliant and in good standing. We also offer fast, friendly, dependable service for incorporation filings in any state, specializing in Limited Liability Companies (LLCs), C-Corporations, and S-Corporations.
We earn a commission if you make a purchase, at no additional cost to you.