An LLC contract, also known as an operating agreement, is a legal document that details a limited liability company's business operation. An LLC is a relatively new business structure that combines elements of other business entities. The advantages of forming an LLC include:

  • Limited liability, which means owners (called members) are protected from business debts and obligations. Their personal assets cannot be seized beyond the amount of their original investment in the company.
  • Pass-through taxation in which members report profit and loss of the business on their individual tax returns. The business itself does not file taxes.
  • Credibility with vendors, clients, and partners that comes with an official business entity.
  • Management flexibility.

What Is an LLC Operating Agreement?

The operating agreement is sometimes called operations agreement or setup agreement. Common operational documents required or recommended for an LLC include:

  • LLC worksheet
  • Business loan application
  • Buy-sell agreement
  • Employee application and handbook.

The operating agreement serves as a written record of:

  • Member rights and obligations
  • Management policies and procedures
  • Operational framework, including the bylaws and financial administration. 

Why You Should Create an Operating Agreement

The LLC operating agreement is critical, even for single-member LLCs, since it protects your limited liability by establishing the company as a separate legal entity. Without an operating agreement that outlines your business' administrative procedures, you will be subject to the default LLC rules in your state. In a multi-member LLC, having an operating agreement in place can prevent costly, future legal disagreements.

LLCs have much more operational flexibility than corporations do, such as the ability to define each member's funding role and duties. This includes flexibility with defining membership percentages. Unlike with a corporation, an LLC can assign each member an ownership stake regardless of his or her capital contribution to the company.

The operating agreement should also indicate who is responsible for keeping the books and overseeing equitable distribution of profits. This person typically defines the fiscal year and has check-writing privileges on behalf of the LLC. You should define provisions for a regular review of the books, whether annually or quarterly.

In some states, an LLC automatically dissolves when a member leaves the company unless another procedure is defined in the operating agreement. You can decide whether to allow other members to purchase the shares of the member who is leaving, whether the member will be replaced, whether shares must be purchased in a lump sum or in installment, and how assets will be distributed among members if you do dissolve the LLC.

What to Include in the Operating Agreement

When creating an operating agreement for your LLC, include information about:

  • The type of company
  • The products and/or services you provide
  • The name, address, and contribution value of each member
  • Rules about allowing new members
  • Meeting frequency
  • Member voting power and whether it will be based on ownership share and/or other factors
  • Tax classification
  • Procedure for division of profits and losses
  • Dissolution procedures.

How to Prepare an LLC Operating Agreement

The Articles of Organization are the documents filed with the state to create your LLC. While the operating agreement does not need to be filed with the state, it must be prepared and signed in accordance with contract law. It should be kept on record with your other official business documents.

When contracts are not correctly signed and administered, it can affect the limited liability an LLC provides. Any legal document should use the official, legal name of the LLC. The signature line for each member must include his or her legal name and official LLC title

All LLC contracts must reflect that the business, not the owner, is entering into the contract as a separate legal entity. Otherwise, the line between the individual and the LLC is blurred, which can also negate limited liability. Best practice dictates that the contract should include a short statement identifying the capacity by which a member is signing. This is achieved by including his or her correct title along with the full legal name of the LLC.

State law dictates who can sign a legally binding contract on behalf of an LLC. 

If you need help with preparing or executing a contract for your LLC, you can post your job on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.