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Forming a Limited Liability Company (LLC) or another business entity can be an important step in your business journey. When you start an LLC, you will file Articles of Organization with the state and pay a fee.
When you create an LLC, it’s also important to create an LLC operating agreement. An operating agreement is a contract among the members of the LLC that describes how the business will operate.
While a written operating agreement is almost never required by state law to start or run an LLC, failing to create one could open the business owner up to personal liability and open the LLC to legal problems down the road.
Why Would Someone Create An Operating Agreement?
There are many reasons why you may want to create an operating agreement. If you have a multi-member LLC, for example, it’s critically important that you spell out financial terms such as who will be able to sign checks from the business bank account, or who can make certain financial decisions— and what to do if members do not agree.
Business owners usually start out with good intentions, but things can and often do go wrong. It’s rare that everyone agrees on all issues all the time. In a multi-member LLC, your operating agreement can provide a framework for how to navigate disagreements and make sure you’ve discussed these issues before they turn into problems. It can help the business avoid a lot of headaches, and provide a legal framework for key business decisions and activities.
And yes, single-member LLCs should create an operating agreement, too. In fact, it may be even more important to confirm that your business is not operating as a sole proprietorship. It’s not just extra paperwork; it’s key to operating your business legally and professionally.
Some lenders may require you to share a copy to open a business bank account or to get business financing or investment capital, for example. While an LLC isn’t required to build business credit, it can be helpful as some lenders prefer to lend to an LLC or other business entity.
Even more importantly, if you don’t have an operating agreement and your LLC is involved in a lawsuit, you may jeopardize the asset protection benefits of the LLC.
If you are going to invest time and money to form an LLC, make sure you also create an operating agreement.
What Should An Operating Agreement Include?
An LLC operating agreement typically includes the following types of information. If you use an operating agreement template (see examples below), you may want to make sure you customize it to your unique needs.
Basic Information
Business name, address, purpose etc.
Ownership Interest
The percentage of the business each member owns. If you have a single-member LLC, that’s easy, but in a few states single-member LLCs carry some additional risk so you may want to investigate your options. You’ll also want to address the rights that membership interest grants.
Capital Contributions
How capital contributions will be handled. Members may need to contribute startup funds, or ongoing funds. Spelling out what that entitles them to or how they can get repaid can be important to make sure each member is on the same page.
Profits and Losses
How profits and losses will be distributed. Remember LLCs are considered passthrough entities, and profits or losses appear on member’s individual tax returns. In addition, the LLC may choose to be taxed as an S corporation, which also provides pass through taxation on distributions and losses. Don’t forget to specify who files the taxes.
Powers and Duties
The powers and duties of members and managers. LLCs may be member-managed or or manager-managed. The operating agreement should also specify how managers will be selected if applicable.
Financial Matters
Who handles certain types of financial decisions. Who can audit the LLC? Who can open a business bank account or sign checks? Who can sign business loan agreements or open business credit cards?
Conflicts of Interest
Non-compete and self-dealing. Do you want to restrict members from leaving and taking clients to a new business? Or restrict them from using the services of other businesses they may own?
Member Departure
How members can exit the business is an important topic to address. What happens if a member wants to leave the business? Sell? Transfer ownership? What happens if they divorce or die?
Dissolution
How you’ll close the business. If you decide to call it quits, these procedures can help customize how you’ll close the business.
These are just some of the provisions you may want to include. Your needs will be unique. But keep in mind that when it comes to how the LLC operates, when the operating agreement is silent on a particular matter, state law will apply and those default rules may be less favorable or flexible.
Also keep in mind that an operating agreement can be updated periodically, but if disputes arise or a lawsuit is filed it may be too late to include the changes you need.
Can I Make My Own Operating Agreement?
You can make your own operating agreement. In five states (California, Delaware, Maine, Missouri and New York) you must create an operating agreement but you don’t have to file it with the Secretary of State or any similar authority. (And in four of those states it can be an oral agreement. Always choose a written agreement in business matters.)
There are a number of online services and books that provide free operating agreement templates.
You may also have access to a law library for additional research. While law librarians can’t provide legal advice, they can often help you find resources.
Just remember that you may get what you pay for. If your LLC operating agreement isn’t prepared thoughtfully or overlooks key provisions, you may find yourself paying for that error or omission later.
Where To Find Help With A LLC Operating Agreement
It’s always wise to work with an attorney on legal matters. A law firm with experience in business formations can help you choose the right business structure for your business, decide the state in which to form your LLC or corporation, and to create legal documents.
If you use an incorporation service to form your LLC, it often will provide you with an LLC operating agreement and the ability to customize it. Here are some corporate formation services that offer LLC operating agreements:
ZenBusiness
Operating agreements start at $125 and will be included in Pro and Premium packages
ZenBusiness
LegalNature
Offers a customizable operating agreement template and affordable business documents by monthly or annual subscription.
Rocket Lawyer
Offers the ability to create a free online LLC operating agreement.
RocketLawyer
Incorporate.com
Offers an LLC operating agreement with higher services, and and add-on for basic services.
Inc Authority
Inc Authority’s Starter and Fast Track bundles both include an operating agreement.
Incorporation Services by Inc Authority
Doola
Doola’s LLC formation service ($197 + filing fees) includes an operating agreement.
Tailor Brands
Tailor Brands offers an operating agreement as an add-on when forming an LLC. Pricing is available at checkout.
IncFile
All IncFile LLC packages include an operating agreement.
Note that incorporation services may not necessarily offer legal services or legal advice. Be sure to ask if that’s important to you.
What Are Good Examples Of An Operating Agreement?
Because LLC operating agreements aren’t filed with the state, it can be hard to find publicly available examples. Here are a few that can give an idea of the provisions one might contain:
Example of actual operating agreement from SEC filings
Example of LLC operating agreement from North Carolina State Extension (with explanations)
Template for LLC operating agreement from Pennsylvania Society of Tax & Accounting Professionals
LLC Operating Agreement Template from REI Women’s Business Center
What Is The Difference Between An LLC Operating Agreement And Articles Of Incorporation?
The basic answer here is that if you choose to operate your small business as an LLC, you need articles of organization and you should have an operating agreement; but if you form a corporation, you need articles of incorporation and bylaws.
There are some differences; the key one being that in most states when you form a corporation you must file the articles of incorporation with the state. Although you’ll file articles of organization for an LLC, you don’t need to file the operating agreement. That means operating agreements are private internal documents while articles of incorporation are public.
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