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The Operating Agreement is the legal guideline for your company. You can obtain an operating agreement online, in an LLC formation book,
from your attorney, or from the library. You can also create your own custom agreement by visiting your county law
library and requesting the legal forms book for your state.
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The role of attorneys:
- If you and your spouse are the only members, you should meet briefly
with an attorney to discuss your business and to verify that your Operating Agreement is
adequate for your needs.
- If you have outside members, we strongly urge that you talk with an attorney to
discuss your particular business and the legal protections the outside members may need.
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| Where to get an Operating Agreement | |
There are many sources for operating agreements: online services, LLC formation books, your attorney, and your local library.
You can also visit your county law library (it is open to the public) and ask for the book of legal forms and create a do-it-yourself operating agreement.
Here is a sample Operating Agreement provided by startupkits.com. |
| | Some basics |
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Before you can prepare an Operating Agreement, you must decide:
- Will all your Members be entitled to the same privileges? Are all of your Members
going to have the same management, profit, tax allocation, and voting privileges? If not,
your LLC will have different member classes. This Operating Agreement has one member class.
Please consult an experienced professional if you would like to use multiple member classes.
- Will your members have different interests? This Operating Agreement allows you to give
members different percentage shares of the LLC (e.g., Jane Doe gets 60%, John Doe gets 40%).
A member's voting rights and share of profits and losses are proportionate to his or her interest
in the LLC. Each member's percentage interest is documented in Exhibit A to this Agreement.
- Voting This Operating Agreement assumes that the weight of each member's vote
depends on his percentage interest in the LLC's profits. For example, assume an LLC
with five Members, each with different percentage interests.
| Yes votes | % interest | | No votes | % interest |
| Jane Doe | 35% | | John Macintyre | 25% |
| Alice Waters | 16% | | Sandra Allen | 13% |
| | | Mark McClure | 11% |
| Total | 51% | | Total | 49% |
Yes wins 51% to 49%
- Value of non-cash contributions If any member is contributing non-cash (i.e. equipment,
existing business contacts, future services, etc.) everyone must agree on the value of that
contribution so that you will know what percentage interest that member is to receive.
If someone is receiving a member interest in exchange for past or future services,
there may be significant tax effects. Please consult a tax advisor.
- Expectations of the members In this Operating Agreement you choose whether members must
devote their full time to the LLC or not. It prohibits members from participating in competing businesses.
If this is not acceptable
to the members, contact an attorney.
- LLC's financial needs Are the contributions by your members enough money to
run the LLC for a year? Discuss what you might do if additional funds are needed.
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| Here is an example of what a typical operating agreement includes: |
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Operating agreements set forth the agreement on how the LLC will operate.
- Organizational Matters States the LLC's name, how long it will operate (i.e. 25 years),
its principal office in your state and its business activity.
- Capital contributions Each members' financial contribution should be listed in Exhibit A.
The LLC will maintain records showing each members' financial position with the LLC.
Typically no interest will be paid on anyone's financial contribution.
- Records The LLC will maintain records of each member's capital account according to IRS Treasury
Regulation 1.704-1(b)(2)(iv). Basically, this means that each member will have a single
capital account, regardless of whether they have more than one interest in the LLC or when
or how they became a member. A capital account is NOT a separate bank account.
It is simply an accounting record showing who owns the net worth (assets minus liabilities) of the LLC.
A member's capital account may be increased by:
- The amount of money contributed by the member;
- The fair market value of property contributed by the member to the LLC (net of liabilities) and
- Allocations of LLC income and gain to the member
A member's capital account may only be decreased by:
- The amount of money distributed to the member by the LLC.
- The fair market value of property distributed to the member by the LLC (net of liabilities)
- Allocations to the member of LLC expenditures and
- Allocations of LLC loss and deductions.
- Members The LLC members must vote to admit new members (usually the vote must be unanimous).
The terms (monetary contributions, privileges, etc.) can be determined by the members.
Members won't be paid for their work. Instead, all members will share in the LLC's profits according
to their contribution percentage recorded in Exhibit A.
- Management All members have (or do not have) equal management. Contracts over $_________(you enter the amount)
must be signed by _________(you enter the number) members. Certain acts should require unanimous
member approval including mergers, dissolution, and changing the type of business. You must select whether
members must spend full time or not working on the LLC. Usually members are prohibited from participating in
competing activities or disclosing LLC trade secrets. If a member wants to conduct business as an individual with the LLC,
the Operating Agreement should describe how that should be done.
- Tax allocations Profit and loss are usually allocated to the members in proportion to their
membership interest in Exhibit A. Cash distributions are usually made quarterly, but the LLC should retain reasonable
operating capital.
- Net Loss If losses get to the point where members' capital account is equal to the
value of the LLC if it were foreclosed upon, the LLC usually stops allocating additional
losses to the members.
Without this provision, if the LLC continued to allocate losses beyond this point and
the member wrote the losses off
on taxes, it is possible that the member would owe capital gains taxes upon foreclosure.
- Minimum Gain Chargeback, Nonrecourse Deductions, Qualified Income Offset, and Code Section 704(c)
Allocations These provisions are required by the IRS so that your LLC can avoid corporate
taxation. They are very technical and not used by a majority of people. For complete information
consult a tax professional.
- Transferring Interest Typically members can only transfer their interest to another if the
members unanimously agree in writing. If they do not, the new member shall only have a right to
share the LLC's profits, with no management or voting rights.
- Death, dissolution, retirement or bankruptcy of member The other members have ___ (i.e. 90) days to buy the former Members' interest in the LLC. The Operating Agreement should describe how that should be done.
- Books and records The LLC should keep the following books and records at its principal office:
- A current list of members and addresses with their capital account information
- Articles of Organization
- State and federal income tax reports for six years
- Operating Agreement
- Financial statement (if any) for six years
- Books and records for four years.
The LLC should provide members tax reports by March 30 so that they can prepare
individual tax returns. The LLC will keep a separate bank account. Any member (or list members) may endorse
and deposit checks. The members shall determine who is authorized to sign checks.
One member shall be designated at the LLC's tax representative to appear for any tax audits.
- Dissolution The LLC shall dissolve:
- Automatically after ____ years (i.e. 25)unless the members vote to continue it
- If the members vote to dissolve it
- If a member withdraws and the others do not vote to continue it; or
- If virtually all of the LLC's assets are sold.
Members are not guaranteed to be returned any of their initial capital contribution.
- Indemnification The LLC will protect members, officers, employees or other
agents of the LLC for any lawsuit which arises because of their involvement with the LLC.
- Investment Representations Each member has a pre-existing personal or business
relationship with the LLC or the other members. The membership interests were not advertised.
Each member is acquiring a membership interest for personal investment only and without intention
to re-sell or distribute any or part of that interest.
- Miscellaneous Standard legal language.
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| Amending the Operating Agreement |
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In most Agreements, all members must approve any changes to the Operating
Agreement. We suggest that specific language for any changes be reviewed by an attorney.
If you are changing information from the original Articles of Organization,
you must file either a restated
Articles of Organization form or a Certificate of
Amendment form with your state's Secretary of State. |
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| Changing the Articles of Organization |
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Any changes in the
Articles of Organization must be approved by members owning over 50% of the interest in LLC profits.
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| Extending LLC's life |
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After the end of your LLC's life (i.e. 25 years), the LLC will automatically dissolve.
Members may vote to continue the business by filing a
Certificate of Continuation form
with the your state's Secretary of State. |
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| Questions? |
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Contact an attorney experienced in structuring LLCs. |
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