What Goes In Your Operating Agreement?

An operating agreement is a crucial legal document that outlines the structure, management and operation of a limited liability company (LLC). It's the foundation between the members in multi-member LLC's and serves as a contract that allows the company to get some things in order from the very beginning. For single member LLC's, it helps separate the owner, individually, from the business, working to limit personal liability. There are many decisions to be made when getting an LLC up and running: decision making, dispute resolution and profit sharing to name a few. The specific contents of an operating agreement will likely vary greatly from business to business based on the specifics of how they want to operate, but there are certain provisions that should be addressed in order to ensure clarity, protection and effective operation of the company. Here's a rundown of some essential operating agreement clauses. 

  1. Formation and Organization. Your operating agreement should clearly state the name of the company, the names and addresses of the members and what percentage of the company each member owns. It should outline the process of admitting new members and the process or procedures for transferring membership interests and ownership. Additionally, it should specify the rights and responsibilities, and obligations of each member, including any restrictions on decision making powers. 

  2. Management Structure. The operating agreement should define the management structure of the LLC. LLC's can adopt a manager-managed or member-managed approach when it comes to managing the affairs for the business. In a member-managed LLC, all members have the authority to participate in the management and decision-making process. Conversely, a manager-managed LLC delegates management responsibilities to one or more designated managers, who may or may not be members of the LLC.

  3. Capital Contributions and Profit Distributions. The agreement should outline the initial capital contributions made by each member and specify the conditions for future contributions. It should also address how profits and losses will be allocated among the members, considering factors such as the initial capital investments, work contributions, and ownership percentages. Clear provisions should be included regarding the distribution of profits and losses, including whether distributions will be made regularly or at specific intervals.

  4. Decision Making and Voting. To ensure smooth governance, the operating agreement should establish the decision-making process. It should define the voting rights of each member and the criteria for passing resolutions or making significant business decisions. The agreement may require a simple majority, a supermajority, or unanimous consent for certain matters, such as admitting new members, amending the operating agreement, or making substantial financial commitments. Moreover, it should address tie-breaking procedures in case of deadlock or disputes.
  5. Roles and Responsibilities. The operating agreement should outline the roles and responsibilities of members and managers, including their duties, authorities, and fiduciary obligations. This section may specify the scope of a member's involvement in the day-to-day operations, their rights to act on behalf of the LLC, and any limitations on their authority. It should also address matters such as confidentiality, non-competition, and non-disclosure obligations.

  6. Dissolution and Exit Strategy. Provisions regarding the dissolution of the LLC and the exit of members should be included in the operating agreement. It should outline the circumstances under which the LLC may be dissolved, such as by unanimous consent or upon the occurrence of specific events. The agreement should also address buyout options, including the process for valuing a member's interest and the rights of remaining members to purchase that interest in the event of withdrawal, retirement, or death.

  7. Dispute Resolution. To mitigate conflicts and disputes, the operating agreement should include mechanisms for resolving such issues. It may specify procedures for mediation, arbitration, or litigation, along with the choice of jurisdiction. Including alternative dispute resolution methods can help save time and money while maintaining relationships between members.

  8. Amendment and Governing Law. The operating agreement should outline the process for amending the agreement itself, ensuring that changes require the consent of the appropriate majority or unanimous agreement. Additionally, it should specify what laws are governing the operating agreement should an issue ever arise.

  9. Books and Records. The operating agreement should address the LLC's record-keeping requirements, including the maintenance of accurate and up-to-date financial records, minutes of meetings, and member information. It may also specify the rights of members to access and review these records, subject to reasonable restrictions and confidentiality provisions.

  10. Capital Accounts and Member Withdrawals. This section should outline the establishment and maintenance of capital accounts for each member, tracking their respective capital contributions, allocations, and distributions. It may also address the process and conditions for members to withdraw from the LLC, including any restrictions on voluntary withdrawals and the rights of the LLC to redeem or buy back a member's interest.

  11. Non-Compete and Non-Solicitation Provisions. To protect the LLC's interests, the operating agreement may include non-compete and non-solicitation provisions. These clauses prohibit members from engaging in activities that compete with the LLC or soliciting its customers, employees, or suppliers for a specified period of time after leaving the company.

  12. Insurance. Addressing insurance requirements can help safeguard the LLC and its members. The operating agreement may specify the types of insurance coverage that the LLC should obtain, such as general liability insurance, property insurance, or professional liability insurance. It can also outline the obligations of members to maintain appropriate levels of insurance coverage.

  13. Taxation. The operating agreement should contain provisions addressing the tax treatment of the LLC. It should specify the LLC's tax classification (e.g., as a partnership or disregarded entity) and outline the allocation of tax responsibilities among the members. This section may also address the treatment of tax benefits, such as deductions or credits, and the distribution of tax-related documents (e.g., Schedule K-1).

  14. Intellectual Property. If the LLC holds or develops intellectual property, the operating agreement should include provisions to protect and govern its use. It may outline the ownership, licensing, and transfer of intellectual property rights, as well as the obligations of members regarding the protection of confidential information and trade secrets.

  15. Succession Planning. To address the continuity of the LLC in the event of a member's incapacity, retirement, or death, the operating agreement should include provisions for succession planning. It may outline the process for transferring a member's interest to a designated successor or allowing the remaining members to purchase the interest. This section can also address the rights and obligations of heirs, assigns, or estate representatives.

An operating agreement is a vital document that outlines the structure, governance, and operations of an LLC. While the specific provisions may vary based on the nature of the business and the preferences of the members, including the elements discussed above can provide a comprehensive framework for effective management, decision-making, and protection of the LLC's interests. Consulting with legal professionals experienced in LLC formation and management can ensure that an operating agreement meets the specific needs and requirements of the business and its members

Have questions about an operating agreement or getting one setup? Contact Us for a free consultation. 

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