Are you in the process of forming a new limited liability company – on your own or with an online service?
There are thousands of new LLCs formed each day across the nation, but due to the way the laws governing this business entity vary from state to state, there’s still quite a bit of confusion regarding certain elements of this structure.
One of those elements is the operating agreement, which is only legally required in a few states, but is strongly recommended in any state.
The operating agreement is an important document because it outlines some crucial aspects of how your business will be run, and even if your state doesn’t require one by law, you should still create one to reduce the potential for confusion or disagreements down the line. In this article, we’ll discuss all the important details you need to know about the LLC operating agreement.
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What Is an LLC Operating Agreement?
The limited liability company operating agreement is a document that describes how the management and ownership aspects of your business will function.
While the operating agreement is not a legal requirement in most states, it’s still advised that you have one, because it helps guide several different internal aspects of your company’s operations.
Which States Require LLC Operating Agreements by Law?
In most states, you are not legally required to have an operating agreement, and there actually aren’t any states that require you to submit it to the state.
However, every LLC in California, Delaware, Maine, Missouri, and New York does need to have an operating agreement ― although only New York requires you to even write it down, and the other states say that an oral agreement is sufficient.
What’s the Difference Between Single-Member and Multi-Member LLC Operating Agreements?
Single-Member LLC
If you operate a single-member limited liability company (SMLLC), it may seem like the operating agreement is somewhat unnecessary. After all, if your state doesn’t require it, and you’re running the business by yourself, why would you go to the hassle of writing down information that you could just as easily keep track of mentally?
However, one of the main benefits of creating an operating agreement for your SMLLC is that it can help distinguish your business from yourself as an individual. One of the most common ways for an LLC to have its corporate veil pierced ― which is another way of saying your personal asset protection is revoked by the courts ― is if the court rules that your SMLLC is just an extension of your personality, rather than a separate entity that can stand on its own.
If you create an operating agreement for your SMLLC, this helps indicate to the court that you are serious about your business, and that it is clearly a separate entity from yourself.
This isn’t the only benefit of the SMLLC operating agreement though, as you can also designate how you would like your business to be handled after your death, or following another incident that leaves you unable to conduct business yourself.
Multi-Member LLC
The multi-member limited liability company (MMLLC) operating agreement usually contains considerably more information than that of a single-member LLC, and we’ll get to the specifics in a moment when we walk through the different sections.
In general though, an MMLLC will include info about how the owners will vote on business matters, how they will make contributions to the company, how profits will be split, and how a member can be replaced if necessary.
What Information Is In an LLC Operating Agreement?
While there is really no one set way to create an operating agreement for your limited liability company, in general we think it’s a good idea to make sure your operating agreement has the following sections in it.
Keep in mind that some of these sections apply far more to multi-member LLCs than single-member LLCs, and the SMLLC operating agreement can often be quite a simple document.
Organization
The first section in just about any LLC’s operating agreement should describe the initial organization of your business. This section should include simple info like the date and location of your limited liability company’s formation, and also some more detail about the organizational structure of your company. You should explain how many owners your business has (and who they are), along with a brief description of whether your members all have equal ownership, or if there’s an uneven split.
Managerial Structure
Is your business managed by its members, or will you hire a separate manager without ownership interests to oversee the daily operations of your LLC? Either way, you should designate whether you’ve chosen member-management or manager-management in your operating agreement. If you don’t include this info, it will be assumed that your business is managed by its members, which is both the default option and the most common choice.
Voting Rights
With a multi-member LLC, you need to have a plan for how your members will vote on issues regarding the operation of your company. Most MMLLCs have each member casting one vote that is equally weighted, but you can alter this if you would like to. Usually, when LLCs choose different voting structures, it’s because some of the owners are more or less involved than the others, and that is reflected in each member’s voting powers.
Contributions and Distributions
Similarly to the voting rights section, a multi-member LLC can either split up financial contributions and distributions evenly, or there can be varying levels depending on each owner’s level of involvement. Either way, you should absolutely outline how money will be contributed to the company, as well as how your business income will be distributed among the owners.
Usually, these ratios line up with the voting rights, but they certainly don’t have to. No matter how you decide to split up these important financial aspects of your business, it’s crucial to define how your contributions and distributions work, because this is the last thing you want to fight about down the line.
Replacing Members
This section is a good one to include whether you operate an SMLLC or an MMLLC, because every business needs a plan for how the company will proceed if an owner needs to be replaced. A major reason you need to do this is because there are some states that will dissolve an LLC if even one owner leaves the company. Even if that wasn’t the case, it’s strongly advised to have a plan ahead of time rather than scrambling to find a replacement at the last second.
Dissolution Process
Dissolving an LLC is rarely an ideal scenario, but if you end up needing to dissolve your company at any time, you’ll be glad you planned this part ahead. In addition, for one reason or another, some LLCs are only meant to last for a few years to begin with. If that describes your business, having dissolution plans in your operating agreement is even more important.
Other Options
Depending on the nature of your business and how you want to handle certain additional aspects of your operations, you might want to include sections about business meetings, or how to handle your LLC’s banking needs.
How to Create Your LLC Operating Agreement
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You can always draft an operating agreement from scratch, especially considering there’s not really any set format for this document. You can also easily find an online template for free. If you want to make sure your operating agreement is top-notch, you could have a lawyer draw one up for you.
If you also want to have your LLC professionally formed, you could look into a business services company that could handle your formation and also create your operating agreement – like LegalZoom or ZenBusiness.
Conclusion
Even though it’s not an official requirement in most states, we think that every limited liability company should have an operating agreement. There are some situations where an operating agreement can help you avoid legal issues, and at the very least it can make several aspects of business ownership more convenient.
Especially considering how simple this document is to create, and how many hassles it can help you avoid down the line, it’s a bit of a no-brainer to have a well-written operating agreement for your LLC, even if you operate a single-member LLC.
We hope this article helped you answer any questions you might have had about the limited liability company operating agreement, and we wish you a bright business future!