What Is an Operating Agreement?

A Limited Liability Company (LLC) operating agreement is a legal document that establishes relations between company members and sets up their rights, obligations, powers, liabilities, internal policies, and rules.

As its name suggests, an LLC limits its members' responsibility, which means they are not personally responsible for debts or obligations that the company has. An LLC operating agreement is as crucial as articles of organization – the document that proves the company's formation.

Single-Member vs. Multi-Member Operating Agreements

Depending on the number of members, there might be single-member and multi-member LLCs. An LLC operating agreement for those two types of entities will serve the same purpose but have a slightly different form. Let's see how those two documents will differ.

Single-member LLC operating agreement

The primary purpose of such an operating agreement is to solidify its status as a separate business entity and separate it from the establishment's personal property. The document should list the role of the owner in the LLC. The operating agreement should also list the other positions such as registered agents, managers, or officers. It is not required to be filed with any governmental agency, but it should be kept in the owner's records at the principal's place of business.

Even though there is no formal requirement for a single-member operating agreement to be notary acknowledged, it’s highly recommended to sign the operating agreement in front of a notary to prove that the document is authentic and was signed on the exact date mentioned in it.

Multi-member LLC operating agreement

This type of operating agreement is devised for LLCs that have more than one owner. It’s an essential document as it indicates who owns the company, what percentage of the LLC they hold, etc. The operating agreement should be signed in the presence of a notary, and copies should be given to all company members. The original should be kept at the company's principal office address.

In a multi-member LLC operating agreement, there should be information about:

• LLC management;

• procedure for buying and selling members' interests (in the event they want to sell their part, become disabled, or die);

• percentage of interest of each member in the LLC;

• rights and obligations of the owners;

• voting powers of each member;

• way of allocating profits and losses;

• procedure of meetings holding.

But let's consider each of the provisions in an LLC operating agreement in more detail.

What Should an LLC Operating Agreement Include?

An operating agreement is a centerpiece of every LLC. It is a comprehensive document that includes a lot of information on the owners, their powers, responsibilities, etc. Suppose all the essential details are included in an operating agreement. In that case, an LLC status will be protected, and LLC will not resemble a sole proprietorship or partnership, which could jeopardize its members' liability. Every LLC operating agreement should include the following provisions.

Formation of the LLC

In the first provision of the LLC operating agreement, you should include the agreement's date and state where it takes place. This provision should also state when the company was formed, its formal name, and the business entity's registered office. It should also include the business purpose and duration of the operating agreement.

Another piece of information that should appear here is the type of your LLC. A limited liability company can be single-member and multi-member. It should be stated in the operating agreement to help prove the company's status in case it is questioned by any third party, for example, the court.

Equity structures

This section encompasses the following clauses:

• Membership interest. It should state what economic and management interest each of the members has.

• Classes of membership interests. Here, write what interests your LLC will have – there might be non-voting, common, profits, and other types of interests.

• Members contributions and membership accounts. From this clause, it should be clear what form members' contributions might have (cash, property, promissory notes, obligations, a combination of various forms). Add information on whether any additional contributions will accompany initial capital contributions.

• Allocation of profits and losses. Allocation can be proportionate by default, or members can be provided with special economic rights.

Internal management

This section should tell who has the power to manage the LLC (it can be members or managers). If managers are chosen, their names and numbers should be included. The clause should state the powers given and whether there is any compensation they will get.

The provision should include the procedure of how managers should be appointed, when manager meetings can be held, what actions are allowed without organizing a meeting, etc. Another piece of information that should be included is how managers can be removed or replaced.

Voting procedure

Even though there is a default rule of voting in proportion to a member's percentage interest, it can be altered in an LLC operating agreement. The operating agreement can also allocate rights of veto or supermajority votes among certain members or managers.

Limitation of liability and indemnification

In this section of your operating agreement, you should stipulate in what situations members and managers should be held harmless and when the company indemnifies them.

Books and Records

This provision of the operating agreement is self-explanatory. It deals with record-keeping and members' rights to inspect corporate and accounting records of the LLC.

Members meetings

Generally, members of an LLC are required to hold meetings at least once a year. In this section of your operating agreement, you should also include information about:

• when regular and special meetings should be held;

• what events can lead to organizing a meeting;

• when written notice to members should be sent;

• what constitutes a quorum (several members enough to have a meeting);

• what the required number of members to make decisions is;

• who is entitled to vote.

Membership interests and admission

In this section of your LLC operating agreement, the following information should be outlined:

• permissible ways of buying and selling rights among old and new members;

• right of first refusal (gives the LLC members the privilege to purchase interest sold by another member before an outside party buys it; can be applied to a multi-member LLC operating agreement only);

• whether membership transfers are permissible;

• procedure of admission of new members;

• what form members' consent should have.

Withdrawal events

The clause should concern what will happen if a member of the LLC dies or becomes disabled. Usually, the options are to keep the company active or to terminate it.

Dissolution and termination of the company's operation

The section of your operating agreement should specify actions that would allow for the LLC's dissolution and sale of all its property. The other information it should provide is how the assets should be distributed upon the LLC's dissolution, if it is possible for a member to withdraw their funds from the capital account when the business entity should be dissolved, etc.

Amendments

This section should tell that any changes to your LLC operating agreement cannot be made without all or majority of the members' written consents.

Miscellaneous provisions

This provision should enclose any other terms of the operating agreement that were not included in the previous clauses.