What is in an Operating Agreement?
The form and contents of operating agreements vary widely, but most will contain six key sections: Organization, Management and Voting, Capital Contributions, Distributions, Membership Changes, and Dissolution.
Article I: Organization
The first section of the operating agreement deals with the creation of the company. It covers when the company is created, who the members are, and the structure of ownership. If there are multiple members, they may all have equal ownership or different amounts of "units" of ownership.
Article II: Management and Voting
This section addresses how the company is managed and how the members vote.
- The company may be managed by the members or by one or managers that are appointed by the members, and the operating agreement specifies what authority the members or more have over company affairs.
- The company may choose to make decisions though a voting process. Votes may be allocated among the members in any number of ways, including one vote per member, one vote per unit of ownership interest (if the company ownership is described in terms of units), etc. The operating agreement may specify what amount of votes is required for particular actions by the company.
Article III: Capital Contributions
This section covers which members have given money to start the LLC. It also discusses how additional money will be raised by members. For example, an LLC can choose to issue ownership "units" in exchange for money.
Article IV: Distributions
This section provides how the company's profits and losses are shared among members. This might include money, physical property, or other business assets.
Article V: Membership Changes
This section describes the process for adding or removing members. It also states if and when members can transfer their ownership of the company. For example, the company will want to specify what happens if a member dies, a member goes bankrupt, two members divorce, etc.
Article VI: Dissolution
This section of the operating agreement will explain the circumstances in which the company may be or must be dissolved. This is sometimes called “winding up” the affairs of the company.
In addition to these six key sections, operating agreements may address any number of other topics. This depends on circumstances of a particular company. For example, members may wish to include requirements for periodic meetings, restrictions on check signing, or explain how disputes within the company will be handled. Keep in mind that your operating agreement can be updated at any time through a process of your choice.
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Do I Need an Operating Agreement?
LLC's in California, Delaware, Maine, Missouri, Nebraska, and New York are legally required to have an operating agreement.
Even if an operating agreement is not required in your state, it is strongly recommended to have one:
- If you have business partners (Multi-Member LLC):
An operating agreement will help prevent misunderstandings by setting clear expectations about partner roles and responsibilities.
- If you are the sole owner of an LLC (Single Member LLC):
Creating an operating agreement brings credibility to your LLC. This helps to ensure courts uphold the limited liability status of your LLC.
After Completing the Operating Agreement
Once you have finished your operating agreement, you do not need to file it anywhere. However, there are few states that require LLCs to file initial reports and/or publish notice of their formation. Check your local laws to verify your state’s requirements. In most states, you can find information about requirements for LLC formation on the Secretary of State’s website.
It is a good idea to keep a file or binder to hold important documentation for your LLC, including your operating agreement. Keep a copy of the operating agreement for your records and give copies to the members of your LLC.
Following any major company events, such as adding or losing a member, it is a good idea to review and consider updating the operating agreement. An operating agreement can always be amended with the consent of all current members.
Completing the operating agreement is just one of the things that you need to do after forming an LLC. If you haven’t done so already, consider doing the following if it applies to your business:
- Get an EIN. If you are planning on hiring employees or opening business bank accounts, you will need an Employer Identification Number (EIN). Check out our What is an EIN article to learn how to get one for your business.
- Get a business bank account. As you are learning how start your business, it is important to maintain your business’ corporate veil to protect your personal assets if your LLC is sued. One of the major steps you need to take is separating your personal assets from your business - something you can accomplish by conducting all your business transactions through a business bank account.
- Register your LLC for state taxes. Tax requirements vary by state and sometimes by the nature of your business. If you are selling physical products, you will probably need to register for sales & use tax. If you are hiring employees, you will probably need to register for unemployment insurance tax and employee withholding tax.
- Set up an accounting system. Whether you hire a certified public accountant to do it on your own, you need to create an accounting system for your business to keep track of your business’ finances - including bills, expenses, and income.
- Obtain licenses and permits. Your business may be required to get certain licenses and permits, depending on the nature of your business, state laws, and local laws.
- Get business insurance. Almost every business should get business insurance. Whether it’s general liability insurance, a business owner’s policy, or workers’ compensation coverage, you need to make sure your assets are protected in any situation.
Questions About Operating Agreements:
Do you need an operating agreement?
It is highly recommended that all LLCs have an operating agreement. There are six states that legally require LLCs to keep an operating agreement: California, Delaware, Maine, Missouri, Nebraska, and New York. Even if you aren’t in one of those states, creating this document has lots of benefits, and no real downsides, especially since you can have one created for free.
What is the purpose of the operating agreement?
This agreement allows you to set out the financial and working relations among business owners and between members and managers. It determines how decisions within the LLC can be made, ownership stakes, voting rights, and many other structural features of the LLC.
Do you need an operating agreement for a single-member LLC?
If you are in one of the six states that require an operating agreement (California, Delaware, Maine, Missouri, Nebraska, New York) then you are required by law to have an operating agreement. Though single-member LLCs are generally more simple in structure than multi-member LLCs, they still can come into situations where having an operating agreement saves them from hassle and headache.
How do I write an operating agreement?
The simplest way to write an operating agreement is to use our free operating agreement tool. This tool allows you to create the document in an easy to use question and answer format. The end result is a properly written operating agreement that you can use for either a single-member or multi-member LLC.
We also provide a free LLC operating agreement template PDF if you don’t wish to use the customizable tool.
If neither of these solutions works for you, sitting with a business attorney in your state to write up this document is another option.
What needs to be in an operating agreement?
An operating agreement should have all of the information in the six articles mentioned at the beginning of this guide. These articles include management, voting, membership, capital contributions and more.
How much does an operating agreement cost?
Creating an operating doesn’t cost anything if you use a service like our operating agreement tool. If you choose to use an attorney to help you create this document, the price could be anywhere from an hourly rate to a flat fee somewhere around $600 or more.
Who signs an operating agreement?
Every member of the LLC and the manager or managers (if there are any) need to sign the operating agreement. Each signatory should sign a separate signature page. Be sure to sign the document in the proper way to best protect your corporate veil. Learn how to properly sign business documents on your state’s LLC formation page.
Does an operating agreement show ownership?
The operating agreement outlines who owns the LLC and what percentage of ownership each party has. Most of the time the members of an LLC will own a percentage relative to the contribution they made to the formation of the business, such as cash investments, but you can divide up ownership however you like.
What is the difference between bylaws and an operating agreement?
Bylaws are the internal governing documents for a corporation. Operating agreements are similar, defining the internal operating procedures of an LLC. The main difference is that bylaws are created for a corporation and operating agreements are created for an LLC.
What do you do with an operating agreement?
Although there are a few states that require you to have a written operating agreement, there are actually very few if any legal requirements for what you have to do with the document once you have created it. It is a good idea to file your operating agreement with other important business documentation so you can access it when you need it for reference or to make changes in the future.
Does an operating agreement need to be notarized?
There is no requirement that the operating agreement is notarized. Even without being notarized, the document is still considered legally enforceable among the parties. However, some businesses will still have the signatures notarized to make things “feel” more official.
Do I need an operating agreement to open a bank account?
You may or may not need an operating agreement to open a bank account. It depends on the bank’s policies and the laws of your state. Since it is relatively easy to create an operating agreement - and free to do when using our tool - you might as well create an operating agreement before trying to open a business account.
Can an LLC operating agreement be changed?
An LLC operating agreement can be changed - in fact, it should be updated if any major changes occur with the company that the operating agreement covers. If members change, ownership percentages change, or some other factors are altered that are referred to in the operating agreement, it is important to update the agreement to reflect those changes.
What if an LLC has no operating agreement?
Every LLC should have an operating agreement to help avoid legal trouble. There are a variety of risks you face without an operating agreement, including:
- You are damaging your corporate veil. Your limited liability status protects you in court. If you are a single-member LLC and you don’t have an operating agreement, the court could fail to take your limited liability status seriously and decide that you are a sole proprietorship.
- Your ownership and management structure could face trouble. The operating agreement puts down in writing the agreement between you and the other owners - including who owns what, who is responsible for what, and who gets paid and how much. One or more owners could forget - accidentally or purposefully - this agreement and act against your interests. If you do not have an operating agreement you will not have any documentation to prove the terms of the original agreement you made with your partners.
- Your business could be subject to state default laws. Many states have default laws about how an LLC must operate. Without defining how your LLC will operate in an operating agreement, you could be forced to adhere to the state’s laws - whether you like them or not.