Updated July 16, 2020
A limited liability company (LLC) operating agreement is an important document that every LLC should consider creating. In fact, in some states, this agreement is required in order to do business. When creating your LLC operating agreement, be sure to include the following information.
9 Elements of an LLC Operating Agreement
- Business Name
- Business Purpose
- Terms of Agreement
- Member and Manager Responsibilities
- Allocation of Profits, Losses, and Distributions
- Books and Records
- Limitations on Liability and Other Legal Additions
A limited liability company operating agreement is an important legal document that details the agreement between the owners. In a single member LLC, an operating agreement is still used to separate the company from the individual and is therefore essential for liability protection. The LLC operating agreement is similar to the bylaws that a corporation creates to provide more detailed specifications on business operations.
Depending on the state where the LLC is formed, documents may need to be filed to establish the business. Some states require LLC articles of organization, which are similar to the required articles of incorporation for a corporation. However, while the articles of organization for an LLC formally establish the business according to state laws, the LLC operating agreement may not be required at all. So why do you need one? These documents help establish the primary benefit of an LLC, which is the limited liability protection it provides.
An LLC forms a separate entity for business purposes but allows profit and taxes to pass on to the owners without the double taxation that corporations face. For example, consider a sole proprietorship or a general partnership that has not adequately prepared for liability issues. If a liability issue arises for any reason, or if the business fails and banks or investors are trying to recover their losses, they may be able to take the business assets. Without adequate liability protection, it is possible for courts to go after the owner’s personal assets. A single-member LLC and multi-member LLC are also at risk of losing liability protection if certain conditions are not met. Beyond the liability benefit, an LLC operating agreement can help prevent disputes from forming between the owners of the company.
9 Elements of an LLC Operating Agreement
A well written LLC operating agreement can spell out ownership, allocations, member responsibilities, and conflict resolution processes. You can find an LLC operating agreement template online which will help prove written consent on the part of the other LLC members. Keep reading for more about the key information an LLC operating agreement provides.
1. Business Name
The first thing to include in your LLC operating agreement is the business name. This section of the document can also include information about a “Doing Business As” name. A DBA is a name that a business may use in lieu of the registered name. If you are writing your own LLC Operating Agreement, be sure to do a business name search to ensure the name is available. You may also be able to reserve your business name for a small fee while you prepare the rest of your business documents. If you do this, be sure to record all of your out-of-pocket expenses and keep receipts of business-related purchases for calculating your total start-up costs.
2. Business Purpose
The business purpose is the part of an LLC operating agreement that provides a detailed explanation of the services and goods the business provides. This can be altered later if a more appropriate business purpose is identified. However, some states that require an LLC operating agreement may also require a very specific classification. For example, the North American Industry Classification System (NAICS) uses codes for each business type. Exploring these codes can help pinpoint components of the business purpose. In the case of real estate, for example, there are many benefits to setting up an LLC. However, depending on your business purpose and expected life cycle as well as investment needs, you may want to consider a different business entity structure.
This section, as with many others, can be as detailed as you want. Or it can be as simple as: “Medical Supplies Manufacturer or Online Retail Store.” You may benefit from consulting with an experienced attorney, especially as some states have specific requirements when it comes to your LLC Operating Agreement. There are many additional benefits of working with an attorney, such as attorney-client relationship privileges.
3. Terms of Agreement
The owners who create the LLC must specify how long the business is supposed to last. This can be for any amount of time unless limited by state law. It may be possible to specify a yearly renewal requirement or allow the LLC to operate indefinitely. Depending on the number of members in the LLC, it may be a good idea to require a certain percentage of owners to agree to major changes to the business. For example, changing the length of the agreement might be something that requires the consensus of a majority of owners.
The great thing about limited liability companies is that they are so versatile. You can operate the LLC as a sole proprietor or as a partnership. Depending on which tax forms and state laws the LLC must follow, you could also structure the LLC as a corporation and even an S-corp. However, this range in versatility does invite the added risk of losing liability protection for not taking the necessary steps to prove the separation of the LLC.
The ownership section of an LLC operating agreement can contain a great deal of information. The agreement should define whether it is a single member or multi member LLC. List the members, their names and addresses, and the percentage of the company that each owns. This is a good time to describe the voting rights of members.
The company operating agreement is signed by all of the LLC members and acts as a binding agreement. An important component of any operating agreement template is a section for LLC members to make capital contributions to the business. This can include assets, services, a promissory note, and more. Each member should carefully review the LLC operating agreement before giving written consent. It would be wise to consult with a lawyer to ensure you are fairly represented in your new LLC.
The ownership section can also determine how ownership changes are handled. This can include buyouts of ownership percentage or share, if allowed, as well as any conflict resolution processes. You should also define how the company will handle dissolution. The best way to avoid future disagreements with other members is to clearly specify how every aspect of the business will be managed.
The management section of an LLC operating agreement can discuss if the LLC will hire a manager or if the members will manage the LLC themselves. If a manager is going to be hired, the document should detail the hiring process, onboarding, and performance review procedures. Many states require an LLC to nominate a registered agent who must receive important correspondence on behalf of the business. Include the registered agent and secondary contact information for future reference.
6. Member and Manager Responsibilities
You can use this section to detail the duties and responsibilities of both members and managers in relation to the business. This can include defining duties of loyalty, care, good faith, and more. The LLC operating agreement should include the details of daily business operations for both members and managers. Also, include the terms or procedures for manager removal and replacement, including a resolution process.
You can use this section to outline certain fiduciary matters. Discuss how money is to be handled and tracked. For example, do you want to include a section prohibiting managers who have a conflict of interest? There are many important concepts you may want to lay out in this document.
7. Allocation of Profits, Losses, and Distributions
How the business chooses to pay its owners is another very important section of an LLC operating agreement. This part describes how profits are distributed. Again, the versatile nature of an LLC allows many different structures. You can distribute profits independently, with no bearing on how ownership is structured, but keep in mind this may not change how the owners are taxed. Because most forms of an LLC allow for pass-through taxation, owners will be taxed on the profits in relation to their ownership percentage.
This section should also discuss distributions and other financial issues related to disbursements. For example, in any given fiscal year, an LLC or limited partnership agreement template may include a section for a capital account. This can be used by the LLC members to make withdrawals or additional capital contributions. Typically, the use of capital, as well as the regulations for the capital account, are included in the company operating agreement. Some businesses, like corporations, face Treasury regulation which impacts how processes must be handled.
8. Books and Records
Books and records are required for many businesses. However, the requirements for these records can vary by state. Books refer to the actual physical books that businesses used to record transactions. Keeping the books in good order meant updating the book to reflect all business transactions regularly. Today, many businesses benefit from electronic record-keeping, inventory tracking, and automatic data entry to complete this task.
In this section, be sure to note whether you will follow a calendar tax year or fiscal tax year, and the subsequent due dates for required business documents. Records can be details of transactions in the form of receipts, invoices, summaries of work, minutes from meetings, bills, and summaries of periodic profit as well as expenses. Some states require businesses to retain certain documents even if they do not have to file them. Many of these records can be accessed or stored electronically, but some states require physical records.
Business records, such as meetings held, major votes passed, members in attendance, and lengths of meetings, are a great way to prove the operating agreement is being executed as it was written. You could also analyze the profits and losses through available documents to determine important business trends or concerns that are holding the company back from succeeding.
9. Limitations on Liability and Other Legal Additions
This section of the LLC operating agreement may be one of the most important. It could be all that stands between a lawyer and your personal assets if the business were to come under legal attack. There are important steps that must be taken in order to preserve your personal liability, including proving the separation of the company and the individual owners. You can do this by holding regular meetings, even as a single member LLC, keeping separate financial accounts for business transactions, and not using personal assets for the business (and vice versa). You may also want to include meeting rules and clearly state how debts and liabilities belong to the company alone and not members. You may also include other legal provisions, such as confidentiality agreements, non-competes, or a section on severability. Talk with a legal professional at Anderson Advisors for more information on what you must include to protect yourself legally in your state.
How to Create an LLC Operating Agreement
There are many ways to create an LLC Operating Agreement. You could use a free resource, download a template, and watch do-it-yourself videos online. You may also be able to meet with a volunteer at a local Small Business Administration (SBA) location. Some business owners buy software to help complete this important step, or they may hire a contractor on a freelance marketplace to cut costs.
Keep in mind that you typically get what you pay for, as the saying goes. The best way to create an LLC operating agreement is to consult with an experienced legal professional who knows the legal requirements for your state.
LLC Operating Agreements
A limited liability company (LLC) operating agreement is an important business document that can help protect your personal assets from seizure. This document serves many business functions and acts as a legal agreement between owners.
Business owners can detail the daily operations of the business, as well as define the duties and responsibilities of members and managers. An LLC operating agreement should include many important details about the company. It’s common for this document to become quite large and span many pages. The more details you can provide ahead of time, the better your business will be prepared. You may also be able to avoid disagreements that often cause other businesses to fail when members come to odds.
The LLC operating agreement also serves to detail how profits and losses are handled, as well as other financial issues, including books and records. There is a lot of important information to include, and a significant risk of losing personal assets if the agreement is created incorrectly. You can rid yourself of worries by contacting a legal firm with a proven track record of success. Call Anderson Advisors today for assistance creating the LLC operating agreement for your business.
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