Understanding an LLC Operating Agreement

A limited liability company (LLC) operating agreement is the governing document for your business. It's used to list the owners and the shares they own, and sets out the rules for how the LLC will operate and terminate in the future. You can also draft it to further solidify your intent to limit the liability of each of the owners, so that there's no question about personal liability. Understanding an LLC operating agreement is important to any owner in a LLC, because it’s the blueprint for how your LLC will work.

Understanding LLCs

Whether you call it a limited liability company or a limited liability corporation, the purpose for forming one is to shield the owners from personal liability and to simplify tax and other rules that traditional corporations are subject to. For example, an LLC is not taxed as a separate entity like a C corporation, which means the owners can file their profit and loss on their individual tax returns.  You can be the sole owner of a LLC, but even then, you should draft and sign an operating agreement to document how your LLC operates. Doing so makes it clear to others that the LLC is a separate entity, and that you're not just a sole proprietorship. You should also buy business insurance for cases where you may be held personally liable for the actions you take when operating the LLC.

How an LLC Operating Agreement Works

If you and the other owners of your business don't draft an operating agreement, the business will be subject to the default state laws. By writing one, you have more control over how your LLC will run. Courts will also look at the provisions of the operating agreement to make a ruling if you or the other owners file a lawsuit.  A judge will also give it more weight than state laws as long as the agreement does not violate any laws. If there's a dispute between you and others who own or control the business, all sides can refer to the operation agreement first to reach a resolution. Here are some of the main points that an operating agreement should cover:

  • Profit and loss shares of each owner
  • Duties of each owner
  • Plan for managing the LLC
  • Voting rules and quorum
  • Rules for selling interest or transfer of interest due to death
  • How to buyout other owners
  • Procedures for making important decisions

When you decide these provisions and write them out, you'll have a much easier time resolving the disputes that are inevitable for most businesses. You'll also have documentation that a third party, such as a judge or mediator, can refer to in order to determine the intent of the parties.

Before you submit your Articles of Organization or Certificate of Formation to create an LLC in your state, you should negotiate and sign your LLC operating agreement. You can include a provision that states that formation of the LLC is pending.


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