Simple LLC Operating Agreement: Everything You Need to Know
A simple LLC Operating Agreement is the terms set forth by the members that determine how the business will be managed.6 min read
A simple LLC Operating Agreement is the terms set forth by the members that determine how the business will be managed.
What Is a Simple LLC Operating Agreement?
Members must determine how they want to manage a business, through a simple LLC Operating Agreement they can make sure that these terms will be clear to everyone. In other words, it is a binding agreement among the members defining the structure of the Limited Liability Company (LLC). Although not every state requires an operating agreement, it is still smart to use one to describe the management structure and ownership of the company. This type of agreement is similar in theory and practice to the agreement between partners in a limited partnership. One of the purposes of the agreement is to prevent conflict among the owners of a business, as well as determine how to resolve any conflicts that may arise.
Reasons to Form a Simple LLC Operating Agreement
- Creating an operating agreement is not a daunting task. Each business may be different in terms of what it offers, but there is standard basic information that is applicable to all businesses.
- An operating agreement is created either before or after the initial formation of the LLC.
- An operating agreement clarifies how the company will be operated before they sign off.
- With an operating agreement in place, questions about operating procedures are clearly stated, which means less confusion, uncertainty, conflict, and stress throughout the course of the LLC.
- An operating agreement can be short and to the point, if it covers the key details for managing the LLC.
- It is not required that the Operating Agreement be submitted to any state or federal agency.
What Is an LLC?
A limited liability company, or LLC, is a type of business entity that provides limited liability protection to the members. This protection limits the personal risk for each member on any business debts. As soon as an LLC's status changes to active in the state in which it operates, the next step is creating an operating agreement. If any of the following apply to the LLC, the member(s) should include provisions around them:
- Pass-through taxation and terms
- Disbursement of profits
- Addition of new members
- Removal of members
Since the operating agreement is the set of procedures members are putting into place, it's important to include all areas that impact the functionality of the LLC. Many of the areas will depend on the type of business venture the LLC is operating and the type of LLC (single, multi, or managed). The following includes many of the basics involved in writing an LLC operating agreement.
Single, Multi, or Managed-Member
For a company with one owner, an operating agreement is an important piece of paperwork as it validates the status of the business as an entity. Should a third party question the status of a business or if a legal representative of the court requested a copy of the agreement and none was available, it could be grounds to have the entity status designation removed. For companies with multiple owners, an operating agreement lays out the groundwork for the operation of the company for all members to read and agree to. A multi-member managed LLC consists of more than one owner (two) each with the focus of being part of the daily operations and interactions of the LLC. An operating agreement is a binding contract that guarantees everyone is on the same page when it comes to managing the company.
Basic Business Information
Include the following when creating an operating agreement:
- Business name
- Business address
- Services provided by the LLC
- The effective date of the operating agreement
- A listing of all the members (these are the people who have invested money in the business for a share of ownership)
Division of Ownership, Profits, Losses, and Authority
An LLC doesn't have to divide its losses and profits based on ownership. This is one way in which an LLC differs from a traditional corporation. The operating agreement can outline how (or if) dividends are paid or whether the dividends are at the discretion of the managers for manager-run LLCs. Areas to cover in this section of the operating agreement include:
- Listing the financial contribution of each member.
- Outlining the ownership interest of each member and what percentage of the losses and profits each will receive (in most cases, these are directly proportional).
- Deciding how additional contributions affect a member's ownership status or their profits and losses.
- Determining how often and under what conditions dividends are distributed; annually, semi-annually, monthly, or quarterly.
- Deciding if unanimous or majority rules when voting on decisions affecting the LLC. The voting rights section should outline whether major decisions require a unanimous or majority vote.
- It must be determined if all members will be required to sign legal documents, such as committing to a financial contract, or if one person will be designated for that responsibility.
- The operating agreement will specify how the LLC is to be managed, the business structure, naming a registered agent, selecting managers, detailing what meetings members will be required to attend, and the addition or removal of members.
- Deciding what restrictions to impose on the manager and/or the manager's authority to make certain decisions regarding areas such as financial contracts or commitments, operation of the LLC regarding the kind of services it provides, or the company's involvement in the stock market.
In an LLC, the owners are called the members instead of stockholders since this business formation doesn't use stock shares. The ownership interest in the company, also referred to as proportionate interest, is the amount each member contributed when the company was started. The operating agreement must clearly state the percentage of ownership for each member.
An operating agreement should also include details about any meetings that the members or managers are required to schedule and/or attend. Some of the most common options include annual meetings and quarterly reviews, although the members of the LLC can decide how often they want to meet when establishing or modifying the agreement.
Buyout and Dissolution
Although the members of an LLC may not want to think about the company being dissolved or buying one another out, it's critical to include a provision that addresses these actions. This section should explain any plans for dissolution, as well as the procedure for dissolution if needed. Some companies form with the plan to dissolve on a specific date. If this applies, make sure to include the date in the dissolution provision of the agreement.
A member may choose to leave the business for any reason. Make sure the operating agreement addresses what will happen if a member exits for any of the following reasons:
- Voluntary exit: the agreement may allow other members to buy out the departing member.
- Involuntary exit: often due to the vote of other members. The agreement should specify whether this is permitted and any conditions for the forced exit of a member.
- Personal bankruptcy: although personal finances aren't as at risk in an LLC as they are in other types of business formations, personal financial troubles can still impact the business. An LLC agreement may outline the conditions of a member filing bankruptcy, such as forced exit and a buyout.
- Disability or death: if a member is unable to perform their functions, the agreement may outline what happens next. In the event of a death, the member may have a will in place that transfers ownership to an heir, but this could cause the other members to lose control of the business. Include a provision that restricts the transfer to another member without approval by the other members.
- Divorce: in some states, divorce could result in the spouse of the member receiving 50 percent of the member's ownership interest in the company. The provision that restricts transfer without approval can prevent this from happening, although you may choose to include an additional provision that specifically addresses divorce and the option for the LLC to purchase the ownership interest from the member going through the process of divorce.
Drafting an Operating Agreement
When drafting your own operating agreement for an LLC, start by coming up with a name. When an LLC has multiple owners, each should carefully review each section of the operating agreement since it impacts everyone. The most important sections are those that outline distribution and ownership interests. If two or more members will be involved in running the LLC on a daily basis, make sure to have a multi-member LLC operating agreement in place. If the members of an LLC don't select the management structure, it will be member-managed by default in most states. In the case that the members won't run the business, the LLC should have a manager-managed operating agreement in place.
The next step to drafting an operating agreement is including the principal place of business. This is also known as the main address, company headquarters, or principal office address. Next, include the date of the business formation and in what state it was formed. The LLC members must also choose a registered agent. This is an individual or business who is appointed to receive any notices on behalf of the business, including legal notices and documentation from the state. These documents would be sent to the address of the registered agent provided.
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