Frequently, I’m asked, “What do you put in an operating agreement?” And like any good lawyer, I respond “Depends.”
I’m not avoiding the question. Rather what’s goes in to an operating agreement depends on many factors. For example, membership size and funding. The typical operating agreement for a single member LLC is about 10 pages. The average operating agreement I draft for a two or more member LLC is usually about 50 pages. That’s a big difference in content between the two. So, it’s not a simple of answer.
As a matter of fact, “What do you put in an operating agreement?” is a HUGE question.
I’ve put together a list, and I’ve tried to narrow it down to what I believe is the “greatest hits”, of elements of an operating agreement. Use it as a “mix-tape” to review or create yours.
Formation of Company
Operating agreements state how the business was formed. For example, “the Limited Liability Company was formed by filing articles of organization with the Colorado Secretary of State.”
Above all, the purpose of the company should be specifically stated. Don’t overly generalize your purpose. Such as, “to undertake and pursue all activities permitted under Colorado law.” Listing the specific purpose in your agreement may protect you personally under the doctrine of ultra vires. Additionally, the agreement should state if the business is going to be in business for a number of years, after an event, or perpetually.
PRO TIP: The more specific you can be in your operating agreement throughout, the better.
On becoming a member or owner of an LLC your membership interest is usually a percentage interest or a units interest. Just like stocks in a corporation, a membership interest has economic rights as well as management rights. These rights or interests can be divvied in whichever way members choose. As an example, a membership interest can have economic rights, but no management rights.
Limitation on Liability
Include language stating the members are not liable beyond their initial investment.
Location of Business
The operating agreement must say where the company’s principle place of business is. In addition, it must also state who is the registered agent.
Your operating agreement must state how it is taxed. LLC’s are taxed as a sole proprietor, partnership, s-corporation, or c-corporation.
An LLC must allocate (assign) profits or losses to members every year at year-end. This method allows the IRS to know how much of the company’s income to tax. Allocations of profits and losses are tied to a member’s economic interests.
Money Coming In
This section describes the initial and ongoing funding of the company. Contributions are usually in the form of cash, property, services, or in the promise to contribute cash, property, or services; or some combination of the above.
Money Going Out
Along with normal distributions for profits and operating costs, it should include also include an end of year distribution to allow members to pay taxes.
Almost always an LLC is a manager-managed business. Therefore, for this to be legally sound, both the operating agreement as well as the articles of organization need to expressly say so. If they both don’t say manager-managed, you’ll need to make the necessary changes. The management section defines the manager’s obligations, duration and removal.
This section discussing the booking keeping, financial records, and bank accounts of the LLC.
Also, Dilution Protections ensure the founding members stake in the company will not diminish after the introduction of new member interests during later funding rounds.
Transfer & Estate Planning Restrictions
To continue, most transfer restrictions include right-of-first refusal to members as well as company buy-back or repurchase agreements. These restrictions protect founding members to be in business with someone not part of the original bargain. Estate planning transfers in an operating agreement avoid probate.
This section addresses how the business ends. The dissolution of an LLC can occur in one of two ways, either voluntary or involuntary. A voluntary dissolution is a sale of the business. Involuntary dissolution occurs when whether it’s by death of the member(s), bankruptcy, or sale.
A Final Word (or three)
So there you have it. I hope you had as much fun reading it, and I did putting it together. 🙂 Remember this is just an outline, and is not all inclusive. If you find your operating agreement is needs help, please schedule an initial consultation.
This article is for educational purposes only, and does not constitute legal advice about your case or situation. There may be exceptions to the information outlined above. Please consult an attorney if you have specific questions about your business.Follow me on social media: