What is an LLC Operating Agreement and Why Do You Need One?

By Nikki Nelson, Customer Service Manager, BizFilings

 

A limited liability company (LLC) is a popular business entity choice for business owners. (A business entity is also known as a business structure.) While an LLC is low on state-required recordkeeping formalities, when forming an LLC, business owners should take time to make sure they have a good LLC operating agreement— as this is the key LLC document that controls how the entity is structured and operates. It also controls the relationship among the members in multi-member LLCs.

In this article, we discuss the basics of why you need an LLC operating agreement and what the document entails.

What is an LLC operating agreement?

The LLC operating agreement, also known as an LLC agreement, establishes the rules and structure for the LLC and can help address any issues that arise during business operations.

Most states have default provisions that address many of these difficulties, but the operating agreement can override these presumptions.

Once signed, the document acts as a binding contract between the members of the LLC, and between the member or members and the LLC, and is a useful reference point for members during the life of the company.

Do I need to file my LLC operating agreement with the state?

LLC operating agreements do not need to be filed with the state.

Do not confuse the LLC operating agreement with the articles of organization. Articles of organization are public documents that are filed with the state to actually form the LLC. The articles contain basic information such as the LLC’s name, whether it will be member or manager managed, and the name and address of the registered agent. LLC operating agreements usually provide much more information, and almost all the provisions for how the business will be managed, and the rights, duties, and liabilities of members and managers are contained in the operating agreement. An operating agreement is a private document.

Am I required by law to have an operating agreement for my LLC?

Most states require an LLC operating agreement. Some people are confused by that because the statute will use language such as that the operating agreement can be written, oral, or implied. An implied agreement basically means that if there is no written or oral agreement it is assumed that the members want to be governed by the default provisions. However, even if a state did not require an operating agreement, it’s a smart business move to have one, and even smarter to have one in writing.

The agreement can protect your company’s status, ensure that each member abides by the rules, and help mitigate any issues or misunderstandings that can arise — even for single member LLCs.

Too often, when forming an LLC, the members rely on verbal agreements that can lead to friction or misunderstanding down the line. With a written operating agreement in place, members have agreed upon rules and procedures they can refer to in the event of a conflict. Failure to have an operating agreement, whether written or oral, can also leave LLC members at the mercy of state statutes, which can be vague, confusing, subject to change and may not match the members’ intentions.

Think of an operating agreement as a document that allows you to "future-proof" your company. When (not "if") the law changes, your LLC may find itself operating under rules that the members did not envision when the company was created. In any given year, over a dozen states amend their laws. Some of these changes are small, but others can have a significant impact on LLCs formed or operating in that state.

And while most states do not require LLCs to have a written operating agreement, having the agreement in writing can reduce uncertainties and is generally recommended. Here’s a sample operating agreement for a Delaware LLC.

Does an LLC operating agreement need to be notarized?

An LLC operating agreement does not need to be notarized.

Basic information to include when creating an LLC operating agreement

Among the items that an LLC operating agreement should address are the following:

  • How the LLC will be managed by its members or manager
  • How the management team will be selected
  • How key business decisions will be made
  • What actions require a vote by the members (and what percentage is required for approval)
  • The duties and responsibilities of the members
  • How profits, losses, and tax items will be allocated among members
  • The procedure for transferring ownership interests or bringing in additional members
  • Events that could trigger the dissolution of the LLC
  • Succession plans
  • When and how the LLC will be dissolved

It’s always best to have a lawyer draft your operating agreement or, if you want to try drafting your own, have a lawyer review it before the members sign. But if you want to try drafting an LLC operating document yourself be careful to avoid free templates. Your agreement should take into consideration the type of business and the state in which you operate. It should also describe the members’ understanding of what their financial and management rights will be. Free templates can often lead to errors. For example, they can omit critical language or terms that describe your business. Or they set forth the members’ rights in ways the members do not want. Certain states may also require the use of specific language that could be missing from the template.

Missing information has consequences. It can leave your business vulnerable to legal trouble and conflict between LLC members. Without detailed instructions such as how to resolve disagreements, business owners may be required to pursue costly litigation.

Other tips and considerations for the LLC operating agreement

Once your agreement is signed, keep copies with your other confidential business records. But don’t forget about it! The LLC operating agreement should be reviewed annually to ensure it still reflects the wishes of members and addresses operational issues that override the default provisions of state law.

As always, consult an attorney and accountant for assistance with the financial and legal aspects of your LLC operating agreement.

 

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