What is an LLC operating agreement?

An LLC operating agreement is a legally binding document that outlines the LLC’s preferred operating, management and financial procedures. Its purpose is to guide the business’s internal operations and ensure the LLC serves its owners’ interests. 

For example, it often includes details about members’ ownership rights and percentages, the business’s legal structure (in this case, an LLC) and protocols for key events that may happen within the company, such as how new members will be inducted, how the organization can be dissolved and how member meetings will be held.

Depending on the state where an LLC is formed, an operating agreement may or may not be required by law. However, operating agreements are always beneficial documents to have on file.

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How do LLC operating agreements work? 

An operating agreement is crafted by the initial members of an LLC. Because each member contributes to its creation, members must come to an agreement on how the LLC will run and any differences in opinion.

Once agreed upon, all members of the LLC sign the document to create a legally binding agreement. From there, the operating agreement is kept with other core LLC documentation, such as its certificate of organization, for future reference. 

The operating agreement is often used to resolve member disputes, as guidance through key LLC lifecycle events and as supporting documentation for common business tasks such as opening a bank account. 

In addition to giving the LLC tools to complete key business tasks, as a legally binding document, an agreement provides legal protection. For example, by putting operating best practices in writing, members ensure that state default LLC operating rules are overridden by the operating practices the LLC’s members deem most appropriate for organizational success. 

In addition, the document can be used in court to defend its members against a lawsuit. For example, the document will usually confirm the organization’s limited liability status, thereby helping to enhance the protection of members’ personal assets should the LLC ever be sued. 

An operating agreement is a document that often grows and adapts to the LLC’s needs. For example, if permitted by the operating agreement itself, members can amend its contents to address new needs. To do so, members can add an amendment to the operating agreement, vote on its adoption and sign it.

Tip: An LLC’s operating agreement should be reviewed annually to ensure it still meets the LLC’s needs.

What’s in an operating agreement? 

An operating agreement lays out the key policies, procedures, provisions and responsibilities of an LLC’s members. As such, it often includes the following information: 

• The LLC’s name.
• The LLC’s management structure. 
• Confirmation of the company’s limited liability structure. 
• Its members’ names and contact information. 
• The initial contributions and ownership percentages of each LLC member. 
• How profits, losses and tax items are allocated among members. 
• Each member’s rights, duties and responsibilities. 
• How ownership percentages can be transferred from one member to another (in the event of a member buy-out or death, for example).
• The LLC’s accounting methods (cash or accrual basis, for example). 
• How new members can be inducted.
• The actions that require a vote by members. 
• When and how the operating agreement can be amended as well as who can enact amendments.
• How the LLC can be dissolved.

4 benefits of an operating agreement

Limited liability protection

An operating agreement can serve as evidence of the entity’s separation from its owners by including key provisions such as confirming the company’s LLC structure and each member’s ownership percentages. In this way, the business’s assets are also separated from its members’ personal assets. 

By clearly demonstrating this separation in a legally binding document, the LLC can defend the business’s limited liability protection in the event of a lawsuit against the LLC or the LLC’s need to file for bankruptcy. In these cases, only business assets can be taken to satisfy company liabilities, not members’ personal homes, vehicles or other assets.

Control

Each state has default rules regarding how an LLC can and should operate, and they are subject to change at any time. This means that businesses without an operating agreement are at the whim of changing laws regarding their operational rules and procedures. In addition, existing and changing laws may be contrary to the LLC’s needs. 

An operating agreement offers control against these laws as its content often overrides the state’s default rules. For example, by including relevant provisions, members can customize how profits and losses are distributed, even if state rules dictate other distribution rules. Such provisions can override state rules so long as the state does not specifically dictate otherwise regarding a specific duty or right.

Dispute prevention and resolution

While many LLCs rely on oral agreements between members, unwritten agreements can lead to misunderstandings and conflict among members throughout the life of the LLC. A written document, however, offers a clear understanding of the original agreement and helps prevent or resolve member disputes. This guidance helps to protect the LLC against dissolution, as irreconcilable member disputes can end in the LLC’s dissolution.

Meeting institutional requirements

Some institutions require an LLC’s operating agreement to be provided as a basis for a business transaction. These institutions often have the power to significantly impact the LLC’s continued existence or enhanced success. 

For example, some investors require access to an LLC’s operating agreement before agreeing to an investment. As such, the LLC may miss out on key provisions without an operating agreement in place. 

In addition, some banks also request an operating agreement before granting approval to open an LLC bank account. A bank account may be necessary to separate members’ personal assets from business assets, a step often required to confirm a business’s limited liability status in case the LLC is ever sued.

Featured LLC service offers

ZenBusiness

Learn More

Via ZenBusiness’ website

Free version available

Yes

Lowest published package price

$199

Live chat

Yes: Human

LegalZoom

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Via LegalZoom’s website

Free version available

Yes

Lowest published package price

$249

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Yes

Northwest Registered Agent

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Via Northwest’s website

Free version available

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Lowest published package price

$39

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Yes

Affordable ways to create an operating agreement

Many LLC formation companies, including Rocket Lawyer and Northwest Registered Agent, offer free LLC operating agreement templates. In fact, Rocket Lawyer offers an online operating agreement tool that asks LLC members key questions, then fills out the operating agreement on the LLC’s behalf. 

However, these templates are often quite generic and sometimes do not include key provisions, language or customizations that may benefit the unique needs of the LLC. For this reason, LLCs can lean on these templates to create a first draft of their operating agreement, but we strongly recommend LLC members consult a lawyer to finalize the document. Many LLC formation companies offer access to such legal counsel for an extra fee, including Rocket Lawyer and LegalZoom.