An operating agreement is a legal document that defines various rules and guidelines for a limited liability company (LLC).
If you’re forming an LLC with multiple members, it can be challenging to get everyone on the same page.
Operating agreements become a binding contract between LLC members, defining how the business will be taxed, member contributions, operating intent, and more.
Once established, the operating agreement formally governs details of the business for financial decisions, functions, provisions, regulations, and more.
Whether you’re starting a new LLC from scratch or you have an existing LLC, this guide will teach you how to create an operating agreement with ease.
The Easy Parts of Creating an Operating Agreement
For single-member LLCs, creating an operating agreement is super easy. As the sole owner of the business, you have complete control over everything and don’t need to worry about partners or other owners.
Even if you’re starting a multi-member LLC, creating an operating agreement shouldn’t be too much of a challenge.
There are lots of online operating agreement templates that you can follow as well. The best business formation services typically offer solutions for operating agreements.
With LegalZoom, it’s just a matter of answering some simple questions, and the platform will automatically generate an operating agreement for you. Then you just need a signature from the other members to make things official.
It’s also easy to create an operating agreement during the initial business formation process, which is another reason why LegalZoom works so well. Rather than revisiting this step at a later date, it makes sense to handle this when you’re working on state and federal business filings from the beginning.
Operating agreements are inexpensive. Most online business formation services offer operating agreements as an add-on for less than $100. In some cases, operating agreements will be built into your business formation package.
The Difficult Parts of Creating an Operating Agreement
The biggest challenge of creating an operating agreement is getting all of the LLC members on the same page.
When you’re working with partners or different owners, not everyone sees eye-to-eye on everything. That’s why formally creating an operating agreement is so important because it can be used to resolve potential conflicts down the road. But members still must agree to terms from the beginning.
Failing to create an operating agreement presents itself with some challenges too.
If an operating agreement is absent, then your business will automatically be subject to state laws, known as default rules. For example, some states require that all LLC owners equally split the profits—regardless of each person’s contribution. But an operating agreement can clarify these discrepancies and ensure profits are split based on ownership.
Some single-member LLCs don’t think they need to create an operating agreement. However, this could make your personal assets subject to liability if it looks like you’re operating as a sole proprietorship—even if an LLC was formed. The presence of an operating agreement makes things more official in the eyes of the state.
Step 1 – Start an LLC
Technically speaking, creating an operating agreement is one of the many steps required to form an LLC. But you can’t put the cart before the horse—you need to begin the LLC formation process before you can create an operating agreement.
To be clear, operating agreements are strictly designed for limited liability companies.
So if you’re starting a different entity type, an operating agreement won’t work for your situation. For example, C corps and S corps need to file articles of incorporation with the secretary of state. An operating agreement is an LLC equivalent of this type of document.
Use a Business Formation Service
To formally start your LLC, there are several things that you need to accomplish. Using a business formation service will make your life much easier, as you can get everything under one roof—including the operating agreement.
Business formation services file all of the necessary paperwork to formally register your LLC with the state. They help you register your name, set up your taxation, get an EIN (employer identification number), and even provide registered agent services.
Of all of the online business formation options to consider, LegalZoom is the most popular.
Starting at $99, an operating agreement can be added to any LLC formation package. All you need to do is answer some quick questions about your business, and LegalZoom will automatically create an operating agreement for you.
Once completed, you’ll receive a copy in the mail for all of the LLC members to sign.
LegalZoom also has sample operating agreement documents for every state that you can view for free.
Another benefit of using LegalZoom to form your LLC and create the operating agreement is the platform’s “peace of mind review.” They’ll automatically check your answers for discrepancies or missing information. So you’ll be contacted if there are any problems before the documents are officially created and signed.
Over 1.9+ million operating agreements have been created with LegalZoom. So you know it’s a platform that you can trust.
LegalZoom offers a 100% satisfaction guarantee as well. So if you’re unhappy with the operating agreement, you can request a full refund within 60 days of your purchase.
Step 2 – Understand Your State Requirements
Like many aspects of starting a business, laws and regulations for operating agreements vary by state. Some states require operating agreements while others do not.
If your state does require an operating agreement, you should familiarize yourself with those conditions. Usually, the information can be found on your local secretary of state website. Otherwise, you can consult with a lawyer for clarification.
Using a business formation service, as recommended in the previous step, will make this process much easier for you.
Formation services understand the different state requirements and will automatically adjust the operating agreement accordingly to ensure its validity and compliance.
Even if your state does not legally require an operating agreement, it’s still in your best interest to create one.
As of the time of this writing, only five states require LLCs to create an operating agreement. We’ll take a brief look at each one below:
All LLCs in California must have an operating agreement. While California requires an operating agreement for all LLCs, you aren’t required to file the document with the state.
The agreement can be written or oral. All written agreements and amendments must be kept with the LLC business records.
Delaware LLCs must create an operating agreement either before, during, or after filing the business formation paperwork. The agreement can be written, oral, or implied.
Operating agreements in Delaware don’t need to be publicly filed and do not need to contain a list of members or managers.
Similar to Delaware, Maine’s operating agreements can be written, oral, or implied. But they must be created at some point before, during, or after the LLC formation paperwork has been filed.
While the “oral” or “implied” portions of this might make the law seem lenient, it’s in your best interest to put everything in writing to ensure the agreement is actually enforceable.
Missouri requires LLCs to create an operating agreement that contains the rights, powers, and duties of LLC members. The agreement should also contain the LLC’s affairs and how business is conducted.
New York requires LLCs to have a written operating agreement. The document must include the responsibilities of the LLC members, business provisions, preferences, limitations, and how the company will conduct its affairs.
Step 3 – Define Basic Provisions
Regardless of your state or local requirements, all operating agreements should contain common provisions about the LLC. Here’s an overview of what to include:
Basic Company Information
The operating agreement needs to include the name of the LLC. The principal office address and the registered agent information should be listed as well.
Statement of Intent and Business Purpose
Explain the nature of the LLC. Describe what the primary purpose of the business will be.
Some states allow for a general purpose like, “The purpose of Company ABC LLC is to legally operate and conduct business activities permitted in State XYZ.”
Other statements may need to be a bit more specific. For example, a real estate business might define its purpose as “Seeking to buy, sell, own, and rent real estate within State XYZ.”
Don’t get too specific unless you’re required. Keep the purpose ambiguous enough so that it supports the growth of your business over time. It’s also worth noting that the purpose can be changed at any point with an amendment, so don’t let this hold you up too much.
Typically, LLCs will continue to operate unless terminated or dissolved according to state law or the provisions defined in the operating agreement. However, some LLCs will be created for a specific purpose and only exist for a set amount of time.
For example, an LLC formed specifically to build a house may only exist until the project is completed.
The operating agreement should also explain how the LLC plans to be taxed. Even though it isn’t necessarily filed with the state, it’s important to define everything to ensure consistency for all members.
For example, one LLC member can’t elect to be taxed as a sole proprietor while other members choose to be taxed as a corporation. So everyone must be in agreement with how taxes will be handled.
Define all of the procedures and conditions for dissolving the LLC.
Step 4 – Define Member Information, Rights, and Responsibilities
Owners of an LLC are called “members.” A primary portion of the operating agreement and its purpose will describe different aspects of LLC members and their responsibilities.
Here’s an overview of what should be covered:
Member Identification and Capital Contributions
Formally list the names and titles of all LLC members. The list could include everyone’s address and contact information as well.
Describe everyone’s initial capital contributions. Contributions can be defined as cash, property, or services. Make sure you determine the value of the capital contributions for each member.
In some cases, LLCs will need to obtain additional capital down the road. The operating agreement should define whether members are required or not required to make additional contributions to the business.
If and when these additional capital contributions are made, describe how the percentage of ownership or interest in the LLC will change accordingly for each member.
Management Structure and Member Duties
LLCs typically fall into one of two categories—member-managed or manager-managed. The two terms are fairly self-explanatory.
For manager-managed LLCs, the operating agreement should include how the managers will be appointed, how much they’ll be paid, and other similar details. The agreement should also define management’s authority and any limitations.
What actions or decisions would require member approval? All of this will be defined in the operating agreement.
Member duties must be defined in the agreement as well. This will clearly describe which members are required to perform certain operational duties. Responsibility can be delegated in any way that all members see fit.
Describe if members will receive extra compensation for the duties and responsibilities they complete.
Admission of New Members
The agreement should describe if and how any new members to the LLC will be admitted. Describe the circumstances and procedure for any existing members that wish to withdraw from the business.
Are there any actions that will automatically be grounds for removal? A formal procedure must be defined.
The transfer of interest should be included in the operating agreement as well. If an LLC member wishes to sell all or part of their ownership, are there certain rules or restrictions set forth?
Many operating agreements contain a right of first refusal clause. This gives other members the right to buy out another member who wishes to sell before the ownership is transferred elsewhere.
In most cases, members will share profits and losses based on their percentage of ownership. But all of this must be defined in the operating agreement. Otherwise, default state laws would come into play.
Some LLC members agree to be equal partners regardless of everyone’s initial investment and contribution. It all depends on how you define this section in your operating agreement.
Death of a Member
While it might be grim to think about it, people die—it happens. So the operating agreement must include provisions and as it relates to a member’s death.
For example, some operating agreements allow the member’s interest to be passed to an heir, such as a spouse or child. Alternatively, other members might have the right of first refusal before ownership is transferred to someone else.
You could include a provision that allows the transfer of interest to only include the right to profits—not business decisions. So if a member dies, their son or daughter who inherits shares of the business won’t necessarily have any say in operational decisions.
Voting Procedures and Meetings
Describe if and when any meetings will be held. Define the rules related to voting and how votes will be cast.
Are a certain number of votes required for an action? Is it a majority rule? Or does everyone have to be in agreement?
You’ll also need to describe the weight of votes. Does every member have the same voting rights? Or will voting shares be equal to everyone’s percentage of ownership?
Step 5 – Sign, Store, and Prepare For Amendments
Once the operating agreement has been created, the final step is making it official.
All of the members must sign the document. It’s recommended that each person has their own attorney review the operating agreement before things are finalized.
While the operating agreement won’t need to be filed with the state, it must be kept with your business formation documents. Each member should keep a copy for themselves as well.
If there is a dispute between members, the operating agreement can be used to legally enforce a course of action.
Amendments to the operating agreement can be made at any time, so long as all of the members are in agreement.