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LLC Operating Agreement: How-to Guide
Whether you are looking to establish a limited liability company (LLC) or have already established one, one document in particular can help you with smooth business operations and protecting personal liability: the LLC operating agreement (OA). It sets the foundation for your LLC formation, how your business will be run, who has what responsibilities, and how profits will be shared. This document serves as a guideline and establishes your limited liability company (LLC) as a separate legal entity vital for personal liability protection.
This is important because it protects your personal assets, such as your home or savings, from being used to pay the LLC's debts or legal claims. A properly drafted and executed operating agreement formally establishes your LLC as its own legal entity, distinct from you and the other members, by outlining the company's structure, rules, and operations.
Understanding and implementing an LLC operating agreement is important, whether forming a single-member LLC or a multi-member LLC. This guide includes everything you need to know about an LLC operating agreement, why it matters to have a written operating agreement, and how to create one effectively.
What is an LLC operating agreement?
An LLC operating agreement is a detailed legal document that outlines the framework for how your limited liability company (LLC) will function.
This document defines critical aspects of your LLC, including ownership structure, capital contribution, operating procedures, responsibilities, voting rights, profit and loss distribution, decision-making processes, dispute resolution, and exit strategies for members.
It avoids relying solely on the state’s default rules, giving you control over how your business is managed.
Why does every LLC need an operating agreement?
Whether you're a single-member LLC or have multiple members, here’s why every LLC needs an operating agreement:
1. Clarifies ownership and roles
When starting a business with friends or family, it’s important to define who owns what and who does what. An operating agreement prevents confusion by clearly stating:
- Ownership percentages: Who owns how much of the business?
- Responsibilities: Who handles daily tasks, finances, or big decisions?
Clear guidelines reduce misunderstandings, and contributions like money or time are reflected in ownership. It helps manage exits, new members inclusion, or major decisions.
2. Avoids default state rules
While some states require LLCs to have an operating agreement, many don’t. If you skip creating this essential document, your LLC will automatically be governed by your state’s default rules
What are the default rules?
Typically, the default rules govern:
- Ownership: Default rules often assume equal ownership among members, even if one person contributes significantly more in capital or resources than another.
- Profit sharing: In the same way, regardless of how much money, time, or effort each member puts into the company, profits are often split equally. If one member contributes more or plays a bigger role, this could be an issue.
- Decision-making: States also have default provisions for decision-making, but these rules are often vague or too rigid to reflect your business’s actual needs. This can lead to confusion or disputes if the members’ expectations are not aligned.
These default rules are one-size-fits-all and may not be fair to your specific situation.
Example: Let’s say there are two members, one invests $50,000, and the other invests $5,000. Without an operating agreement, profits could legally be split 50/50, which feels unfair.
With an operating agreement, you set your own rules for profit sharing, ownership, and decision-making—customized for your business. It keeps things clear, fair, and in your control.
3. Protects your personal assets
One of the biggest reasons to form an LLC is to protect your personal assets. By proving that your LLC is a separate legal body with its own set of regulations and procedures, an operating agreement strengthens this protection.
Example: If a customer files a lawsuit against your LLC, the court can examine the operating agreement to confirm that your LLC is a distinct entity. As a result, the court is more likely to limit the liability to the assets held by the LLC, protecting your personal savings, home, and other personal property from being seized in the lawsuit. Without a well-structured operating agreement, you might risk being held personally responsible for the LLC’s debts and liabilities.
4. Defines decision-making processes
Decisions—big and small—must be made in any business. The process by which these choices are decided—by unanimous consent, majority vote, or some other means—is described in an operating agreement.
Example: Imagine your LLC is considering opening a second location, which requires a significant financial investment. Without clarity, disagreements could delay or derail the decision. But in case your operating agreement specifies a solution, such as, all members must agree on major financial commitments ensuring everyone is on the same page, that solves everything.
5. Prepares for the unexpected
Life is unpredictable and members might leave, want to sell their share, or may even pass away. An operating agreement outlines how to handle these situations, ensuring the LLC can continue smoothly.
Example: One member may decide to leave the LLC. Without a clear plan, their share could end up being sold to an outsider who doesn’t align with the business’s vision. A buyout clause in the operating agreement allows the remaining members to purchase the departing member’s share, keeping ownership within the group and maintaining stability.
6. Supports member relationships
Misunderstandings can arise even among the best friends or family members. A written agreement sets clear expectations from the start, minimizing confusion and safeguarding relationships.
Example: Two siblings running an LLC might disagree on reinvesting profits versus taking a salary. An operating agreement can spell out exactly how profits are used.
7. Promotes smooth tax management
LLCs have flexibility in how they’re taxed. Whether you opt to be taxed as a sole proprietorship, partnership, or corporation, the operating agreement can document your chosen tax status.
Example: If a single-member LLC opts for “disregarded entity” status for tax purposes, the operating agreement can include this detail for clarity.
While it may mention tax-related topics (like how profits are distributed), the operating agreement is not the same as tax forms or filings. It’s more about the relationships between members and the day-to-day workings of the LLC.
8. Establishes rules for adding new members
If your business grows and you want to hire new members, the operating agreement can outline the process.
Example: The agreement can state that new members must be approved by a unanimous vote and detail how their ownership percentage will be calculated.
9. Handles disputes before they happen
An operating agreement sets out a framework for resolving disputes and operating a smooth-sailing business.
Example: Take two members who disagree over how profits should be reinvested into the business. One wants to expand into a new market, while the other prefers saving the funds for emergencies. The operating agreement can specify how such decisions are made, for example, requiring a majority vote for financial reinvestment.
10. Simplifies dissolution and exit plans
If the LLC ever needs to close, the operating agreement provides a clear roadmap for dissolving the business and dividing its assets.
Example: If one member wants to exit, the agreement can state how their share will be bought out and who will take over their responsibilities.
Unlike documents like the articles of organization, which are filed with the state to officially create your LLC, the operating agreement need not be filed officially in many states. It’s for the LLC members to follow and refer to.
Key elements of an LLC operating agreement
Each element of an LLC operating agreement outlines how the LLC (limited liability company) will function. Keep in mind that operating agreement requirements may vary from state to state, so it’s always best to work with an experienced small business service provider like LegalZoom or a business attorney to draft your agreement. Here is a description of the key elements found in most operating agreements:
1. Basic information and principal place of business
In this section of the LLC operating agreement, include essential details about the company. These basics are necessary to establish the LLC’s identity and ensure it has a clear address for legal purposes.
List the business name, identify a registered agent (a representative of the LLC who receives legal documents), and specify the principal place of business or the main location where the LLC operates.
2. Purpose of the LLC
Here, clarify the LLC's business purpose and inform members of the company’s intended direction.
Describe why the LLC was formed and what kind of business it does. This could be a general purpose, by which the LLC can operate any lawful business, or a specific purpose, like running a sole proprietorship or a joint venture.
3. Member contributions and ownership interest
Establish each member’s stake in the LLC in this section. It is critical for new business owners to understand their rights and responsibilities.
Outline the capital contributions (money or assets) that each LLC member is making to the business. Describe each member’s ownership interest, which is usually represented as a percentage based on their contribution.
4. Profit and loss distribution
This section outlines how your LLC will allocate profits and losses among its members. To set this up, all members must unanimously decide on the distribution terms.
For example, you can divide profits equally or according to ownership percentages. If one member owns 60% of the LLC and another 40%, the agreement may state that, unless otherwise agreed, income and losses will be distributed according to these ownership percentages.
5. Voting rights and decision-making process
In this section of the operating agreement, define how voting rights are distributed among members. It is essential for making company decisions.
It includes voting rules for achieving unanimous consent (where all members agree on a decision) and explains the decision-making framework, especially in multi-member LLCs.
This element is crucial for smooth governance and ensures that all members understand their level of influence in the business.
6. Management responsibilities and structure
Here, clarify who will manage the LLC and how they will do so. The agreement may establish a management structure by specifying a member-managed or manager-managed setup.
Member-managed: In this setup, LLC members (owners) are involved in running the day-to-day operations. Everyone wears multiple hats: making decisions, handling tasks, and keeping things moving.
Example: If you and your two business partners want to be hands-on with everything, from hiring staff to managing finances, a member-managed structure works best.
Manager-managed: In this arrangement, the members appoint one or more managers to run the daily operations while they focus on the big picture. The managers can be members or outside professionals.
7. Financial and tax obligations
The LLC's financial responsibilities and tax classification choices must be covered in this section of the agreement. An LLC with many members, for instance, may be classified as a "partnership" for tax purposes by the agreement, which would mean that the LLC's profits and losses are processed through to the members' individual tax returns.
Additionally, discuss the need for a separate business bank account in order to provide personal liability protection by keeping the LLC's finances separate from personal ones.
8. Dispute resolution and conflict management
Here, you must include a dispute resolution strategy to keep disagreements from interfering with business operations. Incorporate dispute resolution techniques, such as arbitration or mediation, and place a heavy focus on open lines of communication to settle disagreements amicably. By guaranteeing that disputes are handled properly, this aims to protect the business.
9. Exit and succession planning
Outline how members can exit the LLC or how new members can join in this section. It will describe the process of adding or removing members, adjusting ownership distributions, and planning succession if a member leaves. This planning is essential for making sure the business can continue operating smoothly even as members change.
10. Dissolution and liquidation
When an LLC comes to an end, the operating agreement provides a clear roadmap for dissolving and liquidating the business. Here's what to include:
- Filing requirements: Define the filing process of the necessary dissolution paperwork with your state to officially close the LLC. This helps ensure the business is no longer liable for ongoing fees or taxes.
- Settling debts: Describe how any outstanding debts and obligations will be paid off. This includes loans, invoices, and any amounts owed to creditors or suppliers.
- Asset distribution: Explain the division of remaining assets (cash, equipment, property) among the members after clearing debts. Specify in the agreement whether this will follow ownership percentages or another agreed-upon method.
- Final tax filings: Explain the filing requirements for the final tax returns, including notifying the IRS and other relevant tax authorities of the LLC's closure.
11. Books, records, and tax returns
Transparency and compliance depend on keeping detailed records. Here's what to include in this section:
- Record-keeping requirements: Establish how and where the LLC's books and records will be kept. This includes contracts, minutes from meetings, financial statements, and other important documents.
- Tax obligations: Outline procedures for filing federal, state, and local taxes. This includes income taxes, employment taxes, and sales taxes (if applicable).
- Access to records: Specify who can access the records and under what circumstances. This helps maintain accountability among members.
- Annual reviews: Require periodic reviews or audits of financial records to make sure everything is up to date and accurate.
- Responsibility assignment: Designate a member or manager responsible for maintaining records and ensuring tax obligations are met on time.
12. Term
Specify the duration of the business here. For most LLCs, the term is indefinite unless the members choose to dissolve the business. However, some LLCs are set up for a specific project or timeframe.
Example: An LLC created to manage a construction project may dissolve once the project is completed.
13. Bank accounts
This section specifies your separate business bank account. This is important so that personal and business finances remain distinct. This separation is important for legal protection and also simplifies tax reporting.
Example: When a customer writes a check to your LLC, it should go directly into the LLC’s business account, not your personal one.
14. General meetings
Specify general meetings to be scheduled so members can discuss and vote on important business decisions. Regular communication helps keep everyone aligned and prevents misunderstandings.
Example: A quarterly meeting might be held to review profits, approve new hires, or decide on investments.
15. Voluntary withdrawal from the company
Explain how a member can quit the LLC if they choose to, in this section. The OA might require the withdrawing member to provide notice and offer their ownership share to other members before selling it to an outsider.
16. Company’s property
This section makes it clear that LLC assets belong to the business—not individual members. It protects the LLC’s assets in case of personal disputes or financial troubles among members.
Example: If the LLC owns a delivery truck, no single member can claim it as their personal property.
17. Right of first refusal
The right of first refusal clause gives a person or entity the right to have the first opportunity to buy an asset before the owner can offer it to others. It outlines how a member can sell their ownership interest to existing members before reaching out to outsiders. This helps keep control of the LLC within the group.
18. Admission of new members
Here, you must outline how new members can join the LLC. Existing members typically need to agree before a new member is admitted.
Example: If a friend wants to invest in your LLC, the operating agreement might require a unanimous vote from current members to approve them.
19. Withdrawal events
This section must outline specific situations where a member might be forced to leave the LLC. This could include death, bankruptcy, or violation of the agreement. It ensures the LLC can handle unexpected situations without disrupting operations.
20. Force majeure
Every LLC needs protection from being held liable if events go beyond its control (like natural disasters or pandemics) and prevent it from fulfilling obligations. This section will clearly state how to handle such situations.
Example: If a hurricane destroys the LLC’s office, this clause might excuse project delays.
21. Governing law
Outline which state’s laws apply to the LLC and its agreement in this section.
Example: If your LLC operates in Texas, the agreement might state that Texas law governs all matters.
22. Amendment
Outline how the operating agreement can be changed when required. Typically, all members must approve amendments, usually in writing.
23. Assignment
Define here whether members can transfer their ownership interest and under what conditions.
Example: A member might want to assign their interest to a family member, but the agreement could require prior approval from other members.
24. Counterparts; electronic signatures
Specify if the agreement can be signed in separate parts or electronically. It allows for flexibility in how the agreement is executed, ensuring that members can sign the document in multiple locations, even electronically, without having to physically be in the same place or use traditional paper signatures.
25. Severability
This section specifies if one part of the agreement is invalid, the rest still stands. If a clause conflicts with state law, the LLC can remove it without voiding the entire agreement.
26. Notices
Outline how members will be notified about important updates or meetings. The agreement might require notices to be sent via email or certified mail.
27. Entire agreement
Confirm that this document contains everything agreed upon by the members, preventing disputes over unwritten terms.
Example: If a member claims there was a verbal agreement to give them extra profits, this clause protects the LLC from such claims.
28. Waiver
State that if a member doesn’t enforce a part of the agreement, it doesn’t mean that part is no longer valid. For instance, if a member misses a deadline but others don’t raise an issue, the deadline still applies in the future.
29. Headings
This section clarifies that section headings are for convenience and don’t change the meaning of the terms.
Example: A heading like “Voting Rights” doesn’t limit the section to voting—it could also include decision-making rules.
30. Further assurances
By this section, members are required to take additional steps if needed to fulfill the agreement.
Example: If the LLC needs to sign more forms for a loan, all members must cooperate to make it happen.
LLC operating agreement template/sample for US states
Since LLC laws vary by state, it's essential to tailor your operating agreement to meet the specific legal requirements and best practices of your state. In this section, we provide state-specific operating agreement samples to show what these specific OAs can look like.
These sample Operating Agreements (OAs) and state-specific breakdowns are provided for informational purposes only and should not be considered legal advice. These templates are general in nature and may not reflect the most current legal requirements or address your LLC’s unique circumstances. Laws governing LLCs vary by state, so it’s important to ensure compliance with local regulations.
Steps to complete a LegalZoom LLC operating agreement template
Creating your LLC operating agreement with LegalZoom is easy and straightforward. Here’s how it works:
- Answer a few questions online - Start by answering some simple questions. Follow the guided questionnaire to complete all the information for your operating agreement.
- We create and mail your document - Once you’ve provided the necessary information, LegalZoom takes care of the rest. We use people and technology to look over your document and screen for missing info and discrepancies. We then create a customized operating agreement tailored to your LLC’s needs and mail you the completed document.
- Sign it to make it official - After you receive the document, have all LLC members review and sign it. This step formalizes the agreement, making it legally binding and ready to use.
Tips for maintaining and updating your LLC operating agreement
Think of your LLC operating agreement as a living, breathing manual for your company, not as a static piece of paper. It's essential to update and maintain your operating agreement to keep your LLC running efficiently and in compliance with the law. Here’s how and why you should do it:
1. Keep it relevant as your business grows
Why: Your LLC may change over time—whether through new members joining, ownership percentages shifting, or changes in your business goals. Keeping your operating agreement up to date ensures it reflects your LLC’s current structure and operations.
How it helps:
- Avoids disputes by clearly defining ownership and roles
- Ensures compliance with your state’s legal requirements for LLCs
- Provides clarity during audits or legal reviews
When to update:
- After admitting or removing a member
- When you change your LLC's management structure (e.g., switching from member-managed to manager-managed)
- If your LLC's purpose evolves or new ventures are added
2. Regularly review the agreement
Why: Even if your LLC hasn't changed dramatically, it's still a good idea to examine the agreement on a regular basis to ensure it's in compliance with current state laws or best practices.
How it helps:
- Keeps your LLC legally compliant by aligning with state law updates
- Helps identify outdated terms or clauses that need revisions
How often: Many experts recommend reviewing your operating agreement annually, such as during your annual meeting.
3. Get the document changes in writing
Why: Verbal agreements may lead to misunderstandings and are difficult to enforce. To make your operating agreement official, any updates should be written and signed by all members.
How it helps:
- Provides legal proof of agreement among members
- Keeps everyone in the loop and keeps misunderstandings at bay
Pro tip: Always include the date of the amendment and specify which sections of the original agreement are being revised.
4. Address changes in membership
Why: Changes in LLC membership, such as admitting a new member or handling a voluntary withdrawal, require updating the operating agreement.
How it helps:
- Outlines the roles, responsibilities, and ownership percentages of the new or remaining members
- Prevents disputes by clarifying terms for transferring or selling ownership interests
Example: If a member exits the LLC and sells their interest to another member, the agreement should reflect the updated ownership structure and profit-sharing percentages.
5. Stay aligned with financial and tax rules
Why: Your LLC’s financial obligations and tax status may change as your business grows, such as electing to be taxed as an S-Corp or handling profits differently.
How it helps:
- Guarantees that the terms of the profit and loss distribution match the tax classification of your LLC
- Helps streamline tax filing and compliance
When to update: After consulting with an accountant or tax professional about your LLC’s financial strategies.
6. Schedule regular member meetings
Why: Regular meetings give members a chance to review the agreement, discuss updates, and address potential changes.
How it helps:
- Encourages open communication among members
- Helps identify areas in the agreement that may no longer serve the LLC’s needs
How often: While not required, holding quarterly or annual meetings is a great practice. Use these meetings to review the operating agreement alongside other business matters.
7. Consult a legal professional
Why: Laws governing LLCs vary by state and can change over time. Consulting a legal expert is perhaps the best way to help ensure your operating agreement remains compliant and effective.
How it helps:
- Provides peace of mind that your agreement meets legal standards
- Helps you address complex scenarios, like disputes or restructuring
When to consult:
- After significant changes in your LLC
- When state laws affecting LLCs are updated
- If you’re unsure how to handle a specific situation
8. Save and share updated copies
Why: It’s important to share updated operating agreement versions to keep all members informed of changes.
How it helps:
- Promotes transparency and trust among members.
- Ensures everyone has the same reference document during discussions or disputes
Pro tip: Safeguard both digital and physical copies in secure locations and make sure all members sign updated versions.
Conclusion
The legal and economic stability of your LLC depends on an LLC operating agreement. A mindfully crafted operating agreement solidifies your LLC's basis and protects personal assets by defining roles, obligations, and profit distribution.
Frequently asked questions
Does the law require an LLC operating agreement?
Although it is not legally necessary in the majority of states, an LLC operating agreement is strongly advised for efficient operations and legal protection. Certain states do require LLCs to have an operating agreement, including California, Delaware, Maine, Missouri, and New York. Making one is a wise step to prevent future problems and make your company's structure clear, even if it is not required in your state.
What happens if I don’t have an LLC operating agreement?
Without an operating agreement, your LLC may default to state rules that may not align with your business goals.
How often should I update my LLC operating agreement?
It is recommended that it be reviewed annually or whenever significant changes occur in the LLC’s structure.
What’s the difference between a business plan and an operating agreement?
A business plan outlines your future financial projections, strategy, and goals. It functions as a growth roadmap. On the other hand, an operating agreement is primarily concerned with the day-to-day operations of your LLC. It covers important topics like decision-making procedures, ownership percentages, and the general organization of the company. An operating agreement makes sure your LLC functions properly right now, while a business plan looks to the future.
