LLC Agreement: Everything You Need to Know

An LLC operating agreement is a 10 to 20-page contract that lays out the guidance and rules for operating the business. It should always cover:

  • How much of the business each member owns expressed as a percentage
  • Each member's responsibilities and voting privileges
  • The duties and powers of the individual and of the members as a group
  • How profits and losses are allocated
  • Rules related to meetings and voting
  • Issues related to the day-to-day management
  • Buyout and buy-sell provisions, if a member wants to leave and sell his or her share
  • How the death of a member is handled

Member Roles

An LLC operating agreement clarifies the role each member plays in funding the business, as well as day-to-day responsibilities. It gives you flexibility because you can design the company as you see fit. For example, you might agree that one member is going to put up 10 percent of the seed money but do 50 percent of the day-to-day work. You can lay this out in the operating agreement and use it to decide how much ownership that person has in the company. The structure is very clear-cut if there's only one member, so you don't have to lay out any voting policies or accounting duties.

LLC Accounting

Your LLC operating agreement must designate who is keeping the books and doling out profits. This manager will need check-writing privileges, and you'll need to discuss when the fiscal year starts and ends. You also should set out a schedule for reviewing the books. Some LLCs do this every quarter and others every few years.

Member Withdrawal and Dissolution

At some point, one of your members may want to leave the LLC. Since LLCs do not have shareholders, you can lay out how this is handled in your operating agreement. Many businesses let the other members buy out the departing member's interest, either in a lump sum or in payments. Again, that's a decision for the members to make up front via the operating agreement. Your operating agreement should also address how the business will be dissolved if that becomes desirable or necessary.

What is a Limited Liability Company (LLC)?

An LLC is a business structure formed by filing the proper paperwork with your state. As the name suggests, the liability of the members is limited, so they are not personally responsible for company debts or other obligations. Members are those who own a part of the LLC. Each one provides a capital contribution, like money or services or property, in exchange for a percentage of the ownership of the company.

Does An LLC Have Shares Of Stock Like A Corporation?

LLCs do not have shares of stock. Instead, each member owns a percentage of the company, based on the contribution he or she makes toward the start-up capital. Those percentages always add up to 100 percent, no matter how many members. The members can change the operating agreement if everyone signs off on the amendment.

Why an Operating Agreement is Important

While many states don't require an operating agreement, it is unwise to run an LLC without one, even if you are the only member. It helps protect your limited liability status, prevents misunderstandings, and lets you run your business as you see fit without the control of the government.

Protecting Limited Liability Status

The main reason to have an LLC operating agreement is to make sure the courts recognize your limited personal liability. This is especially important if you are the only member because, without that formal agreement, the LLC looks like a sole proprietorship to the courts. The formal written agreement gives credibility to the existence of the LLC.

Distributing Profits and Losses

The LLC operating agreement defines each member's share, but it also needs to answer these questions:

  • What share of the profits does each member receive? Is the distribution mandatory?
  • Will the LLC pay the members at least enough to cover the income tax each year on the allocation of profits?
  • Can members draw at-will from the profits, or are they distributed on a set schedule?

Because members have different financial and tax situations, the allocation of profits and losses is an area that needs careful attention. You may want to run this section of the operating agreement by a tax professional.

Voting Rights

Most management decisions within an LLC are informal, but sometimes a formal vote is required. Your operating agreement can specify one of two voting structures. The most common way is to allocate votes according to the member's percentage ownership of the business. The other option is to give each member one vote, known as per capita voting. No matter which one you choose, make sure it's specified in the operating agreement. You also need to state whether a majority vote carries or if you need unanimity.

Overriding the State Default Rules

Every state has a set of laws related to the basic operation of an LLC. Some of those apply to your business unless you have your own operating agreement in place. For example, some states have a default rule that profits and losses divide equally without regard to investment. Your members probably don't want to do that unless they all invested equally. To avoid this, your operating agreement must describe in great detail how profits and losses are distributed.

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