What is an 'LLC Operating Agreement'

An LLC operating agreement is a document that customizes the terms of a limited liability company according to the specific needs of its owners. It also outlines the financial and functional decision-making in a structured manner. It is similar to articles of incorporation that govern the operations of a corporation. Though writing an operating agreement is not a mandatory requirement for most states, it is nonetheless considered a crucial document that should be included when setting up a limited liability company. The document, once signed by each member (owners), acts as a binding set of rules for them to adhere. The document is drafted to allow owners to govern the internal operations according to their own rules and specifications. The absence of this document means that your business has to be run according to the default rules of your state.

Breaking Down 'LLC Operating Agreement'

An LLC operating agreement is a 10-20 page contract document which sets up guidelines and rules for an LLC. In states such as California, Delaware, Maine, Missouri and New York, it is mandatory to include this document during the incorporation process. While most other states do not insist on including it, it is always considered wise to draft an operating agreement, as it protects the status of a company, comes in handy in times of misunderstandings, and helps in carrying out the business according to the rules set by you.

Businesses that do not sign an operating agreement fall under the default rules outlined by the states. In such a case the rules imposed by the state will be very general in nature and may not be right for every business. For example, in the absence of an operating agreement some state may stipulate that all profits in a LLC are shared equally by each partner regardless of each party's capital contribution. An agreement can also protect partners from any personal liability if it appears they are operating as a sole proprietorship or a partnership.

An operating agreement, once signed, should be kept safely as an important record of the business. 

LLC Operating Agreement Format

There are many issues that must be covered in the LLC operating agreement. The general format of the document includes the following:

  1. Each member's ownership expressed as a percentage
  2. The members' responsibilities and voting rights
  3. A layout of the duties and powers of members
  4. The profit and loss allocation among members
  5. The rules related to holding meetings and taking votes
  6. The issues related to the management of the LLC
  7. Buyout and buy-sell provisions, when a member wants to leave and sell his/her share; also should include what will happen in the event of a member's death.

LLC operating agreements should also outline the specific definitions of terms used in the agreement, as well as list the purpose of the business, a statement of its intent to form, how it will handle new members, how it chooses to be taxed, how long it intend to operate, and where it is located.

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