How to Create an Operating Agreement
Read about Operating Agreements and why they are important for small businesses. Includes important information, key considerations, and details.
Updated on September 17th, 2023
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An LLC (Limited Liability Corporation) Operating Agreement is a legally binding document that defines the structure of a business entity. LLC Operating Agreements set rules for member contributions, routine activities, conflict resolution, admission of new members, and more.
An LLC's primary appeal is the distinction it makes between company and owner. Operating agreements detail the separation between business assets and personal assets, laying the groundwork for the business.
This article looks at the key considerations when creating an LLC Operating Agreement.
Operating Agreement Key Considerations Questionnaire - Free Download
Nine questions to help you create an operating agreement.
1. Do I need to have an Operating Agreement?
Operating Agreements are not mandatory for single-member LLCs. However, individual states determine their own rules.
For instance, if your business operates in California, Alabama, or Ohio, you only need to produce an Operating Agreement if your business has more than one member, while Operating Agreements are mandatory in New Mexico, Arkansas, and the District of Columbia, regardless of the number of members.
In Georgia, Colorado, Kentucky, and Connecticut, Single-Member LLCs are required by law to have Operating Agreements.
2. Do I need to use a lawyer to draft an Operating Agreement?
Working with an attorney is recommended, but not necessary. There are plenty of legal software options that could do the job for you, such as FindLegalForms.com. FindLegalForms.com only needs you to answer a few questions online for your paperwork to be taken care of.
Alternatively, if you're up for the task, you could write it up and file the paperwork yourself. It is prudent, however, to check with an attorney to ensure that all special requirements are being met.
3. What goes into an Operating Agreement?
An LLC Operating Agreement is made up of two documents: the bylaws and the buy/sell agreement. It is important to make this distinction before beginning the process of writing an Operating Agreement.
The corporate bylaws outline the management of the company, from voting procedures to positional power, and the buy/sell agreement dictates things like the procedures to follow when a member withdraws from the company, share buybacks, and member deaths.
It is the combination of these two documents that make the Operating Agreement.
4. How will my taxes be managed?
In order to address tax elections, members should elect from among themselves a tax matters member, and this should be stipulated in the Operating Agreement. It is possible for a situation to arise where the tax matters member, endowed with the power to preside over tax affairs, makes a decision in their own personal interest at the expense of the other members.
In order to prevent this from happening, members need to agree to the tax rules of the LLC before writing the Operating Agreement, so as to ensure that the powers of the tax matters member are rigorously defined.
5. Are there any special provisions I need to make?
An Operating Agreement should have indemnification provisions that protect managers from the decisions they make. While members own the LLC, it is managers who make the most decisions in the daily operations of the business. In certain cases, a decision might be good for the company but go against the interests of a member.
In that case, the Operating Agreement will need to offer protection to managers who face pressure from members to influence a business decision. These are known as indemnification provisions, and should not be overlooked in the agreement.
6. How much does it cost to form an Operating Agreement?
The cost of forming an operating agreement will depend on the number of members in your LLC and your plans for investment and growth. Multi-Member Operating Agreements are more expensive than Single-Members. Legal fees for a Single-Member Operating Agreement can cost between $350.00 and $1,000.00, while a Multi-Member Operating Agreement can cost between $750.00 and $5,000.00.
If you have the legal expertise and the necessary business experience, you can form the Operating Agreement without incurring any legal expenses. There are filing fees, however, whose cost will vary between states but will range between $100.00 and $800.00.
7. Can I act as my own agent?
A registered agent is a third party who oversees the registration of the LLC and attends to other legal matters, including collecting all legal notices and managing lawsuits. The registered agent must reside in the business's state of operations and will need to submit their address and personal details to the state.
However, depending on the state you're in, some Single-Member LLCs are allowed to act as the registered agent, but it is typically recommended to elect a lawyer. The registered agent should be listed in your Operating Agreement.
Read our article for information on where to find a registered agent.
8. Where is my official working location?
If you have more than one working location, you need to decide which location will be your official headquarters before you put it in your Operating Agreement. You should state both the name and location of your Principal Place of Business, include the date your company was formed under a section titled "Formation," and always be sure to keep a copy of your Operating Agreement at your Principal Place of Business.
9. Where can I find an LLC Operating Agreement?
Find more companies offering legal documents online.
What to Include in an Operating Agreement:
- Definitions for key legal terms.
- Name and purpose of the company.
- Principal place of business.
- State how long the LLC will be in existence (typically indefinitely).
- State of Jurisdiction.
- Single or Multi-Member.
- Registered agent.
- Ownership of interests.
- Member contributions.
- Meeting requirements and voting rights.
- Assignment of interests.
- Right of first refusal.
- Owning of company property.
- Adding and withdrawing members.
- Withdrawal of capital.
- Distribution of profits and losses.
- LLC certificates.
- Amendments.
FAQs:
How do you get an operating agreement?
You can create your own operating agreement or choose from a number of software services that provide operating agreement templates for you, or in some cases, create the entire document themselves.
What should be included in an operating agreement?
The priority of an operating agreement should be to detail the ownership of members, the management of the company, and the structure of the LLC, but the document should describe everything from definitions for key legal terms to the distribution of profits and losses.
Why do you need an operating agreement?
Operating agreements are important to have because they define your business structure, protect your limited liability status in court, and allow you to create the rules of operations for your business instead of abiding by the state's default LLC rules. Note that an operating agreement is not a requirement in all states. States like California, Alabama, and Ohio do not require LLCs to have an operating agreement if they are single-member businesses.
How much does an LLC operating agreement cost?
The cost of LLC operating agreements is made up of legal fees and filing fees, although there are various factors that determine the cost. Legal fees range from $350.00 to $1,000.00 for single-member LLCs and $750.00 and $5,000.00 for multi-member ones, while filing fees are dependent on each state and range from $100.00 to $800.00.
Does an operating agreement need to be signed?
Yes. An LLC operating agreement must be signed by each member that enters into the agreement.
Is an LLC agreement the same as an operating agreement?
Yes. Both LLC agreements and LLC operating agreements refer to the same document.
Is an operating agreement a contract?
Yes. The operating agreement is a contract because it binds the members of a company to the terms of the company. If a member is in breach of those terms, the LLC operating agreement can serve as legal recourse.
Can you add someone to an LLC?
The LLC operating agreement plays a significant role in the adding of new members. The operating agreement should describe, in detail, the procedures to follow when admitting new members, including the voting process. When adding a new member, this process of admission must be strictly adhered to. The operating agreement will then need to be amended once the new member is added.
How do I write an operating agreement?
Writing an operating agreement is an 18-step process that includes defining legal terms, stating how long the LLC will be in existence, declaring the ownership of interests, detailing meeting requirements and voting rights, and describing the adding and withdrawal of members, among others.
What is the difference between bylaws and operating agreement?
The bylaws make up one-half of the operating agreement. The other half is the buy/sell agreement. Bylaws describe the management of the company, including things like voting procedures, the minimum and a maximum number of directors, and the way in which shareholders and other meetings may be called. The bylaws may be amended if enough directors vote to change it.