Do I need an operating agreement for my LLC?
An operating agreement is rarely a requirement for starting a business, but it’s essential for running your business. It’s your LLC's most critical governing document. It explains what your business is all about—what it does, how decisions are made, and why. Your operating agreement articulates roles, goals, and expectations. It might even cover who signs the checks. This artifact settles disagreements and puts legal claims to rest.
Although most states do not require operating agreements for LLCs, there are exceptions to the rule – Missouri and New York are two of them. You still won’t need to submit your operating agreement to state agencies though.
While it’s not as important that a sole owner have an operating agreement, it’s still recommended. As a sole owner, you can use the operating agreement to protect yourself from personal liability for business activities. And if you bring on additional owners, having a clear process for buying and selling membership interests will be invaluable.
LLCs with two or more members/owners see the greatest benefit from a well-constructed operating agreement, because a well-crafted one will clearly address responsibilities, investments, and profit share percentages. This can prevent a lot of disagreements and confusion, which in turn saves you time and money.
Operating agreements can help maintain the legal separateness of your LLC from your personal affairs. Without one, a court might interpret the lack of documentation as a lack of intent to actually maintain a limited liability company. This is especially true if you are the sole owner.
"If one day you are called upon to prove that your LLC was properly formed and maintained, the absence of an Operating Agreement may be part of the evidence that you didn't follow corporate formalities."
Michael Doland, Business attorney, Los Angeles
The court could then conclude that your LLC is actually a sole proprietorship or partnership, business structures that do not protect owners from personal liability for business debts or legal issues.
There are two main ways to set up voting on major issues in your LLC: votes weighted in proportion to the owner’s investment or ownership in the business, or one-vote-per-owner. Votes are typically taken at regular meetings, or under other circumstances specified in your operating agreement.
An operating agreement should also describe how decisions are made in the business, what to do if members disagree, and how documentation will be kept of all decisions and meetings.
An operating agreement can also establish specific and unique rules for your LLC, which can protect your company from being subject to the government’s default rules.
For example, by default in many states, profits and losses from the LLC are distributed to members equally. However, members do not always contribute equal amounts to the business, so in such cases, you’ll want to specify the amounts of contributions.
Furthermore, some members may not want to distribute profits and losses in proportion to their membership interests, for tax or other purposes. You must specify these non-proportional distributions, called "special allocations" by the IRS, in the operating agreement.
Creating an operating agreement
Free and low-cost templates for operating agreements are available from many sources online. However, you should never use a template as-is. Review it carefully to ensure it meets your needs. You can also work with a lawyer to craft an operating agreement specifically for your business.
Your operating agreement needs to address the proportions of membership interest and profits and losses, LLC management (including annual meetings, voting powers, and rules), members’ responsibilities (especially if members take on different roles), and how membership interests may be bought and sold.
To get started, you can use Avvo's LLC operating agreement template.
If you create your own operating agreement, you should have a lawyer evaluate it before signing, to ensure that it accurately reflects the laws of your state and the intent of all owners. Co-owners should also have their lawyers review the agreement to ensure that their personal liability and interests are protected.