What is an Operating Agreement for an LLC
An LLC, or limited liability company, is a US business structure that provides business owners with a limited liability, meaning that personal finances won’t be affected by business decisions or obligations. If you’re working with a partner or multiple partners, the limited liability company should definitely have some sort of operating agreement drafted and signed to protect all members and contributions. An LLC operating agreement is essentially a contracted agreement between members outlining the distribution of profits and losses as well as how your limited liability company and its capital gets managed.
Although an LLC operating agreement can serve numerous functions, some of the principal roles of an operating agreement are to solve conflicts between members and issuing obligations. Operating agreements aren’t required by law, but having one that dictates the ebb and flow between members can prove vital—especially when profits and losses come into play. Below we’ll discuss the basics of an operating agreement and why you should consider creating one for all members of your LLC.
What is an Operating Agreement for an LLC?
You may be asking yourself if an operating agreement for an LLC is necessary, and how it can benefit you and your company. An operating agreement is a unique business agreement that describes the inner workings of what we call a Limited Liability Company, or LLC for short. Essentially what an LLC operating agreement does is designate a contract between the owners of the LLC, ensuring that a firm agreement is reached and documented between the members of the LLC in order to protect each individual as they operate business collectively.
Consider the by-laws of a company: they dictate the company’s purpose, duties, and responsibilities, as well as specifying shareholder ownership rights and member contributions. An operating agreement is no different and includes this same information all in one place. Much like the mentioned company by-laws, an operating agreement lists all of the terms and provisions consented to by the members in one document. This shields the owners from unforeseeable adverse circumstances that can negatively impact a business and its capital.
What Information is in an LLC Operating Agreement?
The information in this contract outlines the right course of action for day-to-day transactions and for unusual situations that may arise as the business expands or faces hard times. For instance, the agreed upon document should specify what should occur if a member dies, leaves, or compromises some part of the LLC. Keep in mind that no two LLC operating agreements are the same. Majority members and individual circumstances can be different depending on the situation and individual contributions.
All in all, a well crafted operating agreement will allow you to designate your management structure, define who is liable in certain situations, and it will provide a detailed structural hierarchy of response for many other vital issues that may arise when doing business.
Is an LLC Operating Agreement Necessary for Your Business?
You may be asking yourself if you need an LLC operating agreement, even if you’re quite close with your business partners. You don’t need it by law, nor does the Better Business Bureau require it in most states. However, it is in your best interest to have a structured operating agreement for your LLC. An LLC operating agreement is an important measure that can be used to protect the viability of your business and its members, regardless of how easy things seem in the beginning.
Now, imagine forgoing the option of creating an LLC operating agreement for your business. Not having an LLC operating agreement leaves you at the hands of the state or other members, which may not be to your advantage. For instance, individual states demand that business proceeds get equally divided between each member. Without having an LLC operating agreement, new members with less contributions could be among the even split. So, to alleviate the potential stressors from an agreement that you enter into, it is imperative that you consider an operating agreement to protect your efforts and finances.
Keep in mind that an operating agreement will guarantee that your company is operating under suitable controls that you and your partner agree to on paper. The laws of your contract will exist as the grounds of your LLC, its managers, shareholders, and employees. It’s always a good idea to have written documentation of every agreement between you and your partners, as this avoids any misinterpretations or financial issues that may arise if a documented deal isn’t agreed upon or considered. It’s a strong business practice to protect your efforts and finances, and having an LLC operating agreement is definitely one crucial part of running a successful business.
Now, what if you’re the owner of the LLC and you don’t have any foreseeable partners or new members? Regardless of your standing, you need to have an LLC operating agreement, even for a sole proprietorship LLC. In a situation where you’re a single member, the operating agreement will help you keep the status of your LLC, solely because you can prove that you are an individual owner.
Let a Professional Draft Your Operating Agreement
Let a Professional Draft Your Operating Agreement
What's the Difference Between Single and Multiple Member LLCs?
A single-member LLC has an individual who controls all of the business transactions, information, and contributions. LLC operating agreements are essential in evading conflicts among various members, but an LLC operating agreement still provides advantages to a single-member LLC by annulling state rules in regards to how the LLC operates when arbitration isn’t present. If by any means the agreement is voided, you then would have to comply with state laws, which may not always be in your favor.
How Does Having an LLC Operating Agreement Benefit Your Business?
Having an LLC operating agreement will support your limited liability status by classifying your LLC in such a way that exists independent of the individual. A trademark of an LLC is that members aren’t liable for accidents and additional company responsibilities. Nevertheless, when an LLC operating agreement is nonexistent, your LLC will be a sole proprietorship and not a company.
A multi-member LLC, when fortified with an operating agreement, delineates the ownership, management, and structure of your organization. The lawfully binding agreement lessens the chances of any unsatisfactory disagreement that could arise and threaten the established authority of each member. It clearly and succinctly identifies the rights of each member of the company.
We urge you to set in place an operating agreement concerning your multi-member LLC. It will help you to bypass conflicts among segments of ownership and present the expected outcome in case a disagreement occurs between members. In your LLC operating agreement, it is important to set the initial participation of every individual, identify leadership hierarchy, and outline what will happen if a part of the authority structure leaves the partnership. An LLC operating agreement protects its members and is a necessary part of a successful business.
How Do States Deal with LLC Operating Agreements?
Each agreement is different due to the simple fact that companies entering into these arrangements have varied needs. Therefore, states can include particular wording that gets incorporated into the operating agreements. State governed specifications may vary in terms of what gets written into an LLC operating agreement within their respective state, but the prevailing sentiment is that there are individual sections that apply to every individual and state. Always be sure to verify with your state’s business division as it regards to specifications required for your LLC operating agreement before drafting the document with the company’s members.
What is Covered for Your Business in an LLC Operating Agreement?
An LLC operating agreement can incorporate a lot of important information. The majority of the meaningful details published within an LLC operating agreement can address individual company concerns, their preferences in managing the company, and how inner-workings within the LLC will be executed. Every deal is different, so you’ll want to decide the best course for your business and its members. Below are some important contributions to consider when formulating your operating agreement:
Amount of Control
Ordinarily, every individual’s investment portion in an LLC is established by the amount of capital that each member devoted to the company when it got initially formulated. Sometimes you may decide to split power between members, and this can get listed in your operating agreement by noting the amount of the LLC and the contributions of each member.
In regards to splitting up ownership, there are plenty of reasons why you’d decide to go that route. For instance, you may choose to give more money to owners who contributed to more change or who are working more than others. Of course, this will eventually be dependent on your overall company vision, its capital, and the direction that you choose to go. Just be sure to include these details in your LLC operating agreement.
Dealing with the Ups and Downs
LLC partnerships distribute the profits and losses in their LLC by using what is known as distributive shares. All of these distinctions should be made clear in the underlined LLC operating agreement as members can have different contributions that allow for different distributive shares from the business.
When is the Money Shared?
It’s imperative to specify an agreed upon time in regards to when each member of the LLC will receive payment. You should be sure to dictate whether the earnings will get disseminated weekly, semi-monthly, or removed at leisure from the LLC by the managing partners. If proceeds are issued automatically, you’ll need to determine the extent of the LLC’s profits that will be given out.
Keep in mind that the partners of the LLC must pay taxes to the government on whatever amount of money the LLC ultimately took in. Be sure to examine whether or not the company members will have sufficient capital to handle expenses such as taxes, especially if they don’t readily have access to company profits.
Authority and Business Functions
You must ensure that your operating agreement institutes a managerial hierarchy for your LLC as a reliable framework whereby your LLC will get handled, and what your institution’s functions will inevitably be. Think of this as a draft for governing the ins and outs of the business operations and the company’s capital.
Let a Professional Draft Your Operating Agreement
Let a Professional Draft Your Operating Agreement
What to Consider when Drafting Your LLC Operating Agreement
Who will ultimately run my LLC, and will it be operated by the owners as a single entity or individually? How will conclusions be drawn? Who will make all of the critical decisions? What ultimately dictates the individual roles within the company? Are we going to have a dedicated board of trustees? Who’s going to be the big boss? What is the ownership structure like? What is the capital contribution of each member?
These are vital questions that need an answer. You’ll want to establish the answer to these within the LLC operating agreement. Determining your LLC’s line of command and business functions will ultimately avoid unnecessary trouble and disputes that may arise.
How Do Members Vote on Crucial Decisions?
Normally, day-to-day company resolutions that get conducted within your LLC are made informally. You typically won’t need to put anything on paper or even cast a vote. Nevertheless, if a resolution cannot be reached and it can significantly influence the LLC, a voting process must take place.
Be sure to equip your LLC with approaches to these types of issues. Relying on the stipulated votes is a sure-fire way to avoid any issues that may make it to the state. Also, it’s imperative to dictate the power of each vote. For instance, what number of votes will each member of the company hold? Establishing balloting authority is a necessary process and can be given out based upon ownership percentage.
An adequate voting procedure will determine if a majority of votes is sufficient to resolve or if the LLC will need a super-majority of those in charge to allow a matter to pass. The decision can also land on a unanimous situation, but this is something that every member should approve before any further decision.
Who Figures out the Accounting?
Your LLC operating agreement should stipulate your company’s practice of accounting and the financial timetable your company uses. You should contemplate utilizing an accountant that prepares your financial reports. LLC operating agreements generally incorporate a plan dictating the LLC’s members or administrators to publish an audited profit sheet and verified statements of services and capital to the owners of the LLC. This ensures that everyone stays on the same page.
What Happens If a Member Leaves?
Things never stay the same, and your company will ultimately undergo some changes in the future. When changes occur, it’s imperative that you have plans set in place as part of your operating agreement that will activate if something happens. For instance, if a manager leaves the company of a multi-member LLC, the plans that you previously laid out can quickly rectify the situation.
At other times you may agree to sell each individual’s stake in the company. These sort of agreements require each person to sell their shares to other owners when all or one of the owners quit.
Another thing to consider is death. What happens when a member dies? Terms may be included for outstanding members to acquire the share, you can enable specific people to claim their stock, or you may include a provision that gives distinguished members the power to vote.
What Happens if You Decide to Close the Company?
Unfortunately, things happen, and businesses can close for various reasons. Being equipped with the necessary stipulations in your operating agreement can provide a thorough course of how the company should ultimately dissolve. Yes, it is incredibly difficult to fathom your business failing. That’s why your LLC should have default rules that apply to these unforeseen occurrences, particularly during times when things seem to be getting worse.
An easy way to accomplish this is a voting system. Creating a voting arrangement in your operating agreement will make it easier to dissolve the LLC and disperse the money.
Picking a Tax Structure of an LLC
The tax structure that is common with an LLC is one in which there is a single member or multi-member LLC. Nevertheless, issues may arise that prompt you to change the tax structure already set in place. You can modify your tax arrangement to what is known as a C or S corporation via a proposal submitted to the IRS, regardless of if you already created your LLC or if you intend to create it in the future.
The ways an LLC can be taxed arises due to classification. A single-member or multi-member company is taxed depending on the number of members involved, indicating that LLCs don’t necessarily pay taxes as an entity, each is responsible for their share of taxes because it gets reported on their tax return. However, if you choose to keep the LLC as is and retain the tax structure that it came with, then you won’t need to do any modification to your operating agreement.
What If You Classify as a C or S Corporation?
If you’ve changed the LLC classification from the default title to a C or S classified company, you’ll come to realize that corporations do ultimately pay taxes two times. The first is a tax on the total profits for the corporation, and the second is the tax on the shares that each member receives. There are undoubtedly distinct benefits to listing your company as either a C or S corporation.
The smart choice is to research if the company’s goals and outlined interests alight with an S or C corporation, and that will help you to decide which tax classification is ultimately right for your LLC. Determining your LLC’s tax structure will have a tangible impression on each member as well as the finances of the company. The tax structure is a decision that should not get taken lightly, and due diligence must be applied.
Outlining Your LLC's Structure of Ownership
First, let’s consider a member-owned LLC. A member-owned LLC furnishes each member’s power to restrict the business. Following this arrangement, each of your business partners can own bank accounts, participate in contract negotiations, and make other vital decisions all on the company’s behalf. A member-owned hierarchy is beneficial only if you trust each member of your LLC to deal with the daily company operations.
So what happens if you have a single-member managed LLC? If a single-member LLC is what you’ve chosen, this should get outlined in the operating agreement. The operating agreement should declare the member’s scope of power if the will solely manage the LLC and if the member can operate as the single entity representing the LLC in terms of signing contracts and setting up a bank account in the company’s name.
If you chose the route of using a multi-member operated LLC, the section titled management in your operating agreement should include all the pertinent details that apply to that classification. The operating agreement should consist of the duties of each member, how issues will get resolved between said members, or how the members will conduct everyday business.
However, what happens if you decide to formulate a member-owned hierarchy that boasts multiple members. Below I’ll detail some essential things to include in your operating agreement:
Control of the Company
dictate within the understanding that the power of the business falls solely on the members. Furthermore, you must explain a single member will get appointed the chief executive member is bearing the brunt of the responsibility.
About the Members
Restrict the responsibility of the members and stipulate that they participate in aspects of control, company affairs, management, and contract negotiations.
This portion dictates that importance of listing the duties that each member is responsible for, as well as describing the consequences when a function of the business gets ignored or mishandled.
Assigning a Chief Executive
A chief executive is an individual member whose primary responsibility is managing the transactions of the company, thereby making the majority of the relevant decisions. Keep in mind that if you have a single member LLC, you don’t need a chief executive.
Now, what if you choose to operate your LLC such that one or more administrators manage it? In such an LLC, the managers alone and those whom they appoint as officers hold decision making authority. Keep in mind that management can become comprised of multiple members or an outside party you’ve voted in to hold the role.
Control of the company
In this section, you’ll want to outline in the operating agreement that the LLC is a manager-owned covenant as well as who the manager is. Also, another critical addition would be to describe how said managers get chosen, whether through a form of election or some other method to be defined.
In this particular section, you should take the time to outline each member as well as what their roles will be in the company.
How Can I Create My Own Operating Agreement?
Forming an operating agreement for your LLC isn’t tricky as long as you know what information to include. Some opt to go the route of hiring a lawyer to structure a valid operating agreement that specifies ownership and responsibilities, while other choose to draft the agreement themselves.
With proper research and ingenuity, your LLC can get constructed without hassle. Gather all of your co-owners to discuss what to incorporate in your contract. After you’ve reached an agreement as to what the contents of your operating agreement will be covering, you can head on over to llcformations.com to finalize the entire process. The professionals at llcformations.com offer an intuitive online platform that allows you to prepare your operating agreement hassle-free.