Distributions of Profits and Losses

In addition to defining each owner's distributive share, your operating agreement should answer these questions:

• How much -- if any -- of the LLC's allocated profits (the members' distributive shares) must be distributed to LLC members each year?
• Can members expect the LLC to pay them at least enough to cover the income taxes they'll owe on each year's allocation of LLC profits? (An LLC owner, like a partner in a partnership, has to pay income taxes on the full amount of profits that are "allocated" to him or her, not just on profits that are actually paid out. When profits are plowed back into the business instead of being paid out, they are still treated as income to the owners, in the proportions allocated.)
• Will distributions of profits be made regularly or are the owners entitled to draw at will from the profits of the business?

Because you and your co-owners may have different financial needs and marginal tax rates (tax brackets), the allocation of profits and losses is an area to which you should pay particular attention.

You may want to run the allocation part of your operating agreement by a tax professional, to make sure it achieves the overall results you had in mind.

Voting Rights

While most LLC management decisions are made informally, sometimes a decision is so important or controversial that a formal vote is necessary. There are two ways to split voting power among LLC members: Either each member's voting power corresponds to his or her percentage interest in the business, or each member gets one vote -- called "per capita" voting. Most LLCs mete out votes in proportion to the members' ownership interests. Whichever method you choose, make sure your operating agreement specifies how much voting power each member has, as well as whether a majority of the votes or a unanimous decision will be required to resolve an issue.

Ownership Transitions

Many new business owners neglect to think about what will happen if one owner retires, dies, or decides to sell the owner's interest in the company. These concerns may not be on your mind now, but such situations crop up frequently for small business owners, and it pays to be prepared. Operating agreements should include a buyout scheme -- rules for what will happen when a member leaves the LLC for any reason.

How to Create an Operating Agreement

Obviously, you'll need help beyond this article to make your own operating agreement. There are many sources for blank or sample LLC operating agreements, but you must be sure that your operating agreement is drafted to suit the needs of your business and the laws of your state.

Software that helps you create your own LLC may be your best alternative. For example, LLC Maker (from Nolo) will use your input to customize an operating agreement that suits the needs of you and your co-owners and meets the requirements of your state's laws.

You can also pay a business lawyer for assistance -- in fact, we recommend this for LLCs with more than five owners, and also for those that opt to have a special manager or management group run the LLC. Lawyers typically have several types of standard agreements on hand that can be customized for your LLC. Although using a lawyer can get pricey, the peace of mind you'll gain from knowing that your LLC is protected -- and has adopted operating rules that will best serve its interests -- may well be worth the cost.