An operating agreement is the internal governing document for an LLC. It is a legally binding agreement between the LLC and its members that formalizes the LLC’s rules and structures. Whether you’re in a single-member LLC or a multi-member LLC, the operating agreement is an integral part of your LLC’s management and operations.
Is an Operating Agreement required?
Only a handful of states (CA, NY, MO, ME, and DE, to be exact) require an operating agreement.
But even if an operating agreement is not required, it is still a good idea to have one for your LLC. For multi-member LLCs, it will spell out how decisions will be made, how the LLC’s profits and losses are handled, the rights and responsibilities of the members, and what will happen if a member dies or wants to withdraw from the LLC.
For single-member LLCs, the operating agreement helps uphold the limited liability protection afforded by the LLC. Following these legal and corporate formalities helps avoid having the LLC appear as an “alter ego” and the potential risk of piercing the corporate veil.
What should it include?
The operating agreement will look different for every LLC. But there are a few terms and provisions that will commonly be addressed in an operating agreement:
- Percent of Ownership. the operating agreement will state the percentage of ownership of each of the members.
- Allocations: the operating agreement will describe how the LLC’s profits and losses will be allocated to the members.
- Distributions: the operating agreement state how and when distributions of profits will be made to the members.
- Management: the operating agreement will describe how the LLC will be managed, and if it is member-managed or manager-managed.
- Decision-making: the operating agreement will describe the vote required for different actions.
- Transferability: the operating agreement will set forth the process for which a member’s interest in the LLC can be transferred. This includes situations where a member wants to withdraw or sell his/her interest, or if a member dies, becomes disabled, gets divorced, or files for bankruptcy.
Tune in to this week’s episode of All Up In Yo’ Business to find out how to draft your operating agreement. And be sure to subscribe to our YouTube channel for more All Up In Yo’ Business!
Want more information on business? Check out: The #1 Mistake That Single-Member LLCs Make.