What happens next after you decide to form an LLC for your small business?
The next step is typically to create an LLC operating agreement. This is one of the most vital documents an entrepreneur may have in running a limited liability company.
What’s an Operating Agreement?
The role an operating agreement plays in running an LLC is important. It defines how the LLC will be run by its owner(s) or member(s).
Do you need an operating agreement? Yes — and preferably the agreement should be a written document format. It is possible to skip the writing portion and agree to an oral summary.
However, an oral agreement is not an ideal long-term strategy for a business. Writing out the rules, structure, and regulations for how to run the LLC in an operating agreement allows all member(s) to review the document for any questions or concerns. In the event that your state of incorporation has questions about the validity of your LLC, you may present them with a copy of the operating agreement. This provides proof of the company’s status as a legitimate LLC.
Operating Agreement Information
Now that you understand what an LLC operating agreement is, what sort of information should go into this document? It’s pretty easy to write up! Let’s take a look at some key areas to cover in your operating agreement.
These are the basics of your LLC. This information includes the name of the business, name(s) and address(es) of each member(s), the LLC’s principal business location address, and name and physical address of the registered agent.
What kind of business does your LLC do? Detail this in one sentence using a general description.
Rights and Responsibilities
Who is doing what in the LLC? The operating agreement should outline the daily duties and responsibilities of each member. This may sound like a basic area to cover, but it is highly important. Each member should know exactly what is expected of them. This ensures a general understanding in how much of a say each person has in making business decisions. It also helps to resolve any conflicts or disputes within the LLC.
You know what the business does and the daily roles and responsibilities of its member(s). Now you need to establish what the ownership looks like.
Some LLCs decide to form one of three LLC structures. These include single member LLC, member managed LLC, and manager managed LLC. Make a note of which LLC structure your company is operating as in this document.
Then, determine the portion of the LLC’s profits, losses, and assets each member is entitled to. This may be divided based on initial investment. For example, if one member runs the LLC as a single member LLC they receive 100% of everything. If there are two members that invested the same amount into the LLC, the amount is split on a 50/50 basis. Ownership rights should be discussed with all members. This ensures everyone understands and is okay with how these profits, losses, and assets are divided among members. Additionally, you may wish to indicate the tax structure of the LLC in this section. This allows each member to understand the way the LLC will be taxed.
Joining and Leaving
What happens if the LLC wants to bring on a new member? What if an existing member wants to leave? An operating agreement will plan ahead for the future in outlining rules for gaining and losing members of an LLC.
Consider new members. What will they receive for joining the LLC? What should their initial investment look like? Take into consideration similar guidelines for departing members. What will they be entitled to and how long should they remain involved with the business? Review this section with any other members of the LLC to ensure they understand the guidelines and are able to offer their feedback.
Another area to make note of is what happens in the event of a member’s passing. Clearly outline agreements for how ownership of the LLC may be redistributed among its members.
An LLC may dissolve its business for a variety of reasons. As mentioned above, the passing of a member could lead to the dissolution of an LLC. Or, the business may choose to dissolve because it has simply run its course.
The LLC operating agreement should outline terms for dissolution. These terms may include guidelines for how to divide remaining assets once the LLC’s debts are paid off and rules for whether former members may start or run businesses based on the idea of the dissolved LLC.
As you wrap up your LLC operating agreement, the last section to include is a severability provision. Essentially, this bit of legal boilerplate states that if a provision of the LLC operating agreement should by chance run contrary to state or federal law, all other aspects that are not contrary to the law would still survive.
Once you have drafted your LLC operating agreement, create a few copies. Keep the original document stored in a safe space and give copies to each member of the LLC. Putting the agreements into writing helps protect the interests of each member and the status of the company as an LLC.