Making LLC Operating Agreements
Limited liability company (LLC) operating agreements are much like corporate bylaws in that both types of documents govern the workings of your business.
LLC operating agreements allow the owners of a business to configure the running of their business in a way that best suits their needs. Normally, an operating agreement for an LLC will lay out various key points, such as each co-owner's percentage ownership share of the business. In addition, LLC operating agreements lay out the share of profits - or losses - that each owner will receive, the rights and responsibilities of the owners, and typically also detail what will happen to the business if one of the owners leaves.
Follow along as FindLaw outlines the basics of making an LLC operating agreement. For more information, see our Incorporation and Legal Structures section.
Necessity of LLC Operating Agreements
Depending upon the state that you are running your business in, you may or may not be required by law to write out an operating agreement for your limited liability company. However, even if you state does not require it, it is still a good idea to make an operating agreement for your LLC.
By having an operating agreement for your LLC in place, you have a line of protection that guards the status of your limited personal liability for your business' dealings, and can also avoid or alleviate misunderstandings between owners of the LLC. Having an operating agreement in place can protect this status when and if courts begin looking at your assets to satisfy an obligation of your business. Lastly, each state has default laws you may want to avoid that will govern the running of your LLC if you choose not to make an operating agreement.
Laying out the Ownership and Management
If you are a part owner of an LLC that has multiple owners, you will want to ensure that the operating agreement for your LLC lays out the profit- (and loss-) sharing breakdown between all of the owners. In addition, the operating agreement should also clearly define the managerial structures, laying out procedures for decision making about the business as well as what will happen in the event that one of the owners decides to leave the business. If your LLC does not have an operating agreement in place that takes care of these two issues, you may run into problems when your business makes record profits for a year, or when your long-term business partner decides to leave.
Avoid State Default Rules
Many states have default rules that say that losses and profits should be divided equally among all the owners of the LLC, regardless of their respective ownership interests. However, you can avoid this default rule by agreeing that the share of losses and profits will be split according to the percentage ownership of each member.
Elements to Include in LLC Operating Agreements
Although each LLC operating agreement will probably be a little different, depending upon the needs of each business, there are few essential terms that are contained in a majority of operating agreements. These terms include:
- A breakdown of the ownership percentage of each member;
- The rights and responsibilities of the members;
- A detailed plan showing how losses and profits will be distributed;
- The voting rights of members;
- A management plan for the business;
- Rules for meetings and voting; and
- Buyout or buy-sell rules that govern when a member's sale of an interest, or a member's death or disability.
Most of the time, the ownership percentage is determined by the amount a member gave at the start of the business compared to the total amount given by all members. If you choose to do so, however, you do not have to follow this ownership percentage scheme and can allocate the ownership of the LLC in any way you wish so long as you include the scheme in your operating agreement.
Shares of Profits and Losses
This is often called the distributive share. Under most LLC operating agreements, a member's distributive share is often just a simple calculation under their ownership percentage.
For example, if Dave owns 25 percent of ABC LLC, and the operating agreement dictates that a member's distributive share is equal to his or her ownership share, Dave would take 25 percent of ABC LLC's losses or profits. If ABC LLC made $100,000 in profits for the year, Dave would be entitled to $25,000.
Profits and Losses Special Considerations
You may also want to make some special arrangements within the operating agreement that deal with unique situations. The operating agreement should dictate how much of the distributive share a member is allowed to take each year.
If, for example, the business is new, you may want to consider limiting each member to only taking half of his or her distributive share each year. So, to follow the above example, Dave would only be allowed to take $12,500 of his distributive share, leaving the remainder in the business to help with growth.
Meetings and Voting Rights
The LLC operating agreement for your business should lay out details about meetings and voting rights. In general, there are two voting rights schemes that LLCs commonly use. The first is where each member votes his or her membership percentage. Under this scheme, a person with a 40 percent ownership share has a much larger voting power than a person that only has a 1 percent ownership share. The other option is where each member gets one vote, no matter the size of their ownership shares.
Transitions of Ownership
Your LLC's operating agreement should also lay out the procedures required for transitions of ownership. Often, operating agreements have different procedures for this depending upon the circumstances (such as death, selling, disablementetc). Most often, operating agreements include simple buyout schemes that allow continuing owners to buy out the ownership share of a member that is leaving the company.
Creating an Operating Agreement
While this article may have helped you see some of the more important points to consider when creating an operating agreement for your LLC, you still need to sit down and create the actual document. Consider professional legal help for this step. If your LLC's operating agreement is going to exceed the basics, you may have to consult with a business and commercial law attorney.