While it may not be a requirement to have an operating agreement, it’s actually in the best interest of an LLC to draft one. And by drafting it, I’m referring to creating a written operating agreement. Some LLCs, depending on the number of members, may think an oral agreement is sufficient enough to run a business. However, a written operating agreement defines in writing how the LLC is run. It establishes the rules and structure for the LLC. Members may refer back to the document if they have questions. It’s also readily available in the event the state questions the validity of your LLC.
Ready to draft an operating agreement for your LLC? Here are the key areas to thoroughly cover in this document.
Ownership
What percentage of the LLC is each member entitled to receive? The ownership portion of an operating agreement outlines how the LLC’s profits, losses, and assets are divided among its members.
More often than not, this is contingent on the LLC structure. For example, in a single member LLC there is only one member. As such, their percentage would be 100% because everything belongs to the sole member. It is advised that all LLC members review the ownership section together. This allows everyone to make sure profits, losses, and assets have been properly divided for each member.
Members’ rights and responsibilities
Now that you have a clear understanding of how ownership is distributed, it’s time to outline the LLC’s division of labor.
What are the rights and responsibilities of each member? Every member in an LLC should understand their role within the company and the skills they bring to the table. Additionally, don’t forget to outline in the operating agreement how much say each member has in a business decision and the plan to settle disputes, if there are any, between members.
Joining and leaving the LLC
Every LLC should expect the unexpected with its members. Your operating agreement must be able to touch on protocol for what happens next if a member decides to join or leave the LLC.
If your LLC decides to bring on a new member, outline details in their onboarding process and incentives that the member would receive upon joining the LLC. You should also be able to determine where their initial investment fits within the LLC’s existing ownership portion of the operating agreement.
What happens to members that decide to leave an LLC? Before creating a set of rules, you’ll need to check in with your Secretary of State to see what needs to be done next. For some LLCs, this may be enough for automatic dissolution. A single member LLC that loses its only member, for example, would need to be dissolved since there are no more members in the business.
If a member is leaving, but the LLC is not dissolving, it’s important to detail what they may be entitled to receive upon leaving the company.
Dissolution
Let’s go back to the topic of an LLC’s dissolution. A dissolution is when a business is formally closed with the state. An operating agreement should detail terms for how to dissolve an LLC when (and if) that day should come for the company. Don’t forget to outline the following procedures for dissolution:
Once the LLC’s debts have been paid, determine how the remaining assets will be divided amongst members.
Can former members establish and run companies just like the LLC that just dissolved? Figure out whether or not this is acceptable for individual members.
Severability provision
Close out the LLC operating agreement with a severability provision. This is a standard legal boilerplate. It states that in the event a provision of the operating agreement proves to be contrary to state or federal law, all other aspects that are not contrary to the law should still remain in effect. By including a severability provision, the LLC ensures any tiny oversights do not invalidate the entire agreement.
Finally, don’t forget that members may edit the LLC operating agreement in the future. It’s a good idea to include a provision in the agreement that covers how modifications should be made to the document, otherwise you will have to rely on the state’s default rules for amendments. Review the operating agreement one more time with all members present to make sure there are no errors or inaccurate information. Then, you may finalize the operating agreement for the LLC.
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