An LLC Operating Agreement provides basic rules for how a limited liability company (LLC) operates. It covers how members of an LLC work together, what they contribute, and how they share profits. Founders refer back to the LLC Operating Agreement to answer any of these critical questions. This article describes what should be part of this agreement.
LLC Operating Agreement provides a legal framework for business owners. Photo by rawpixel on Unsplash.
What Is An LLC Operating Agreement?
An LLC Operating Agreement provides the legal framework for a limited liability company (an LLC). Members of the LLC sign this agreement after considering essential issues related to running the business. Although not always strictly required by law, an LLC Operating Agreement has a vital function: it answers the questions business owners have about forming, running, and changing their business.
The LLC Operating Agreement should be a written document that addresses the areas outlined below. Successful companies spend time discussing these issues before going into business. Using a template Operating Agreement or a filing through an online filing service often means that the members of the LLC have not given serious thought to essential issues. This leads to conflict and friction.
Other business entity types use similar documents, but they may be called something different.
What Should The LLC Operating Agreement Address?
How Do Members Join or Leave?
People leave and join companies. Your LLC Operating Agreement should address fundamental questions of how a new member may join the LLC or how a current member may leave. By clearly outlining this process in advance, you avoid expensive headaches and delays should a change in ownership occur.
Additionally, the LLC Operating Agreement must address how LLC interests can be transferred. Without clear guidelines, members may transfer ownership without restriction, which could lead to an unwanted newcomer joining the company.
Finally, if someone leaves the agreement should state what they are entitled to when they leave and how any money should be paid.
Decision Making
An LLC Operating Agreement must outline how members make decisions. Will major decisions require a unanimous vote? A majority vote? Or something different?
What counts as a significant decision? Do some members have the right to make certain decisions on their own? Does every member have the same voting rights?
Ultimately, addressing these questions early on provides essential guidance that prevents simple decisions from becoming conflicts that threaten the company.
Contributions
Also, the LLC Operating Agreement must address what each member needs to contribute to the company. That contribution can come in the form of money, services, intellectual property, or anything else of value. Members should discuss and agree on the contribution and clearly outline it in the LLC Operating Agreement.
Further, the agreement should also make clear when these contributions are due and what happens if the member does not make the required contribution.
Distributions
Finally, the LLC Operating Agreement should address how members receive distributions of money or other value. And when those distributions should be made and on what conditions.
LLC Operating Agreement: California Rules
These rules for creating LLC operating agreement California companies should know. While not a complete list of rules, we give an idea of issues to consider when forming a California LLC.
- The agreement must spell out the rights of members. The operating agreement should spell out the rights of the members. This includes the right to receive payments. Also, it includes the right to vote in major decisions. Cal. Corp. Code §§ 17701.02(r), (aa) and 17701.10(a)(1).
- Will the LLC have multiple membership classes? An LLC can have multiple membership classes. This flexibility allows for non-voting members, profit interests, income interests, and others. Cal. Corp. Code § 17712.01.
- Will the LLC be member-managed or manager-managed? Many LLC owners choose the member-managed option. This means that every member has a hand in management. However, some situations call for a manager-managed LLC, especially where there are passive investors.
- How much money does each member put in to start? Also called “member capital contributions”, this should be defined within the LLC operating agreement. Cal. Corp. Code § 17704.02.
- How will profits, losses, and distributions be shared? Unless specified in the operating agreement, all profits, losses, and distributions will be made according to membership interest. It’s wonderful to know that business owners can change this default. Cal. Corp. Code §§ 17701.10(d) and 17704.04(a), (e).
- How are new members added? New members might wish to join the LLC – consider how that might happen. Also, consider if your company will restrict transfers of membership interests. Cal. Corp. Code §§ 17701.02(aa), 17704.01(c)(1), and 17705.02(f).
- How do you end the company? Everything ends. Consider what happens when you wish to dissolve your LLC. Cal. Corp. Code § 17701.10(c)(8).
It’s clear that the California LLC operating agreement offers a good deal of flexibility. However, when using that flexibility you must ensure that you are complying with relevant California laws governing LLCs.
Should I Use An LLC Operating Agreement Template?
You can find an LLC operating agreement template by searching the Internet. But using it creates risks.
To use an LLC operating agreement template effectively, you must understand how it works. So, you need to know whether you must customize it. Also, you need to know your state’s requirements for a proper LLC operating agreement. Getting this wrong jeopardizes your limited liability protection.
Finally, since every business differs, an LLC operating agreement template does not capture nuance. It might not provide precisely what your company needs. Alternately, it might provide what your company needs but clumsily.
An LLC Operating Agreement represents a foundational document in your business. That’s why serious business owners understand that trying to do it yourself or using an online filing service often doesn’t cut it. By working with an attorney, you get a clear view of what to include in this important document so that you set yourself up for success.
