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An operating agreement is an important document used by Limited Liability Companies (LLCs) to establish rules and guidelines for a company and its members. It may seem a little challenging at first, especially with multiple partner LLCs, but it’s actually quite simple. And once you set it up, it’s a fluid document that you can change in the future as your business grows and changes.
Why it’s worth creating an operating agreement
Operating agreements are not always mandatory, but they are still worth having. They set rules and guidelines for a company while separating personal responsibility from corporate responsibility. This is just as important for single LLCs as for multi-partner LLCs.
Your operating agreement also exists to protect you from legal issues that may arise. These include membership disputes, litigation and investor disputes. Having an operating agreement avoids misunderstandings and shows courts that you started your business with a clear plan and followed rules.
Another thing that makes operating agreements so valuable is that they can help when you scale your business. If you decide to get new members, work with investors or get published, this document will be hugely important.
The best thing about creating an operating agreement is that once it is done, it is done. All you have to do after that is update it with any changes. Once you have created it, you have a document that you can drop back to revise and change.
The investment needed to create an operating agreement
When you create an operating manual, you have a few options for financing it.
You can choose a template that you fill out and update yourself when there are business changes. If you are a sole proprietor and your business is relatively simple, this is a free option that can work.
If you have a multi-partner LLC, consider working directly with a lawyer. This is a much more expensive solution, but it helps you navigate complications from multiple partners or investors. You should seek out a local lawyer to make sure they have knowledge of your state’s rules.
Your third option is to work with a business formation service. Formation Services helps you form an LLC, register it and fill out all the necessary paperwork – including your operating agreement. This is a great opportunity to save both time and money.
There are plenty of great training services to choose from, but LegalZoom is the most popular. It offers a range of services, including the creation of operating agreements, dissolution and LLC formation:
5 steps to creating an operating agreement
Below is a step-by-step guide to building your operating contract from scratch.
# 1 – Form your LLC
The first thing you need to do is form your LLC (if you have already done this, go to step 2!) Operating agreements only work for LLCs and to fill in all the correct details for your operating agreement you need to have your LLC formed and organized.
Deciding all the details before you start working on your operating agreement can save you a lot of time.
There are two main ways you can get started creating your LLC:
Use a lawyer. If you want, you can work directly with a business lawyer to help you set up your LLC. This is a great way to save time and make sure you do everything right. You should always look for a local lawyer to make sure they know about the specific rules of your state. Use a business formation service. If you want to make it easier (and cheaper) to form your LLC, you can choose to undergo a business formation service. These services help you with all the admin like accounting, registration and paperwork.
Regarding the latter option, LegalZoom can help you set up an operating agreement, but it can also help you with the formation of your LLC. They offer LLC formation, both for single LLCs and multi-partner LLCs.
Not only do they help you through the process of forming your LLC, but they also help you choose the right type of taxes as well as guide you without any legal issues. And of course, you get a registered agent who can help you navigate operating agreements.
The cost of forming an LLC with them starts at $ 79 and you have 60 days to get a refund if you are dissatisfied.
Business formation services are a great option for those who want to save money while still doing everything the right way and have expert support throughout the process.
# 2 – Follow state requirements
For most places, an operating agreement is not mandatory. But it is still an important document that you must have for yourself.
However, some governments require you to have an operating agreement. For example, five states in the United States require operating agreements and have special conditions for them. They are New York, California, Maine, Delaware and Missouri.
If your state requires it, do not worry. It can make your life a lot easier as there will be clear instructions on what to include and how to fill it out.
Here’s how to make sure you follow local rules:
Check the website of your local authority. If your state or government requires an operating agreement, chances are the information will be listed on their website. This can include a template, what to fill out, and how to submit and archive it. Hire a local lawyer. If you are not sure about the local requirements, or if you are worried about getting something wrong, contact a local business lawyer. They can help you fill in all the correct information, understand the law and archive it correctly. Use a business formation service. If you are going through a business formation service, e.g. LegalZoom, they can explain to you various state rules and advise you on any upcoming changes to federal policies.
# 3 – Define the basic provisions
Whether your government requires an operating agreement or not, you need an operating agreement that describes the basic information about your business.
If you are a single LLC, this should be quick and easy. If you are a multi-partner LLC, schedule a meeting to discuss the following points and ensure that everyone agrees on the information you want to include in your agreement.
You must first complete your basic business information. This should be easy, whether you are a single LLC or multi-partner. The kind of details you want to include are:
Company Name Company Address Business Purpose Members (Names and Addresses) Register Agents
You do not have to worry about getting too detailed with your business purpose – it’s just explaining what the company does, rather than a mission statement or something.
You also need to define how the business will be taxed on your mode of operation. This is equally important for single and multi-partner LLCs.
For individual members, you need to define whether you want to be taxed as an individual or a business. It may be better to choose a business, as your operating agreement and LLC partly consist of separating you as a person from you as a company.
If you are a multi-partner LLC, make sure all members agree on the tax terms.
Finally, you must specify terms for how the company is dissolved and liquidated.
Your terms may include who and what has the power to trigger a resolution and who can decide when it should be dissolved. You also need to look at how the assets will be distributed upon liquidation.
# 4 – Define membership guidelines
If you have a multi-partner LLC, it is important to set guidelines for member finances, management, and retirement.
This keeps everyone on the same page and avoids disputes. If you are a single LLC, you can still add this section to your operating agreement, but it will take you less time and you will not need all the clauses.
For a multi-partner LLC, make sure all members are clear and agree on each of the following clauses:
The first thing you need to document is everyone’s contribution. List everything each member has contributed, including cash, services, and property.
This is important because it is one of the most likely things to come up again in the future. You will need this information if a member decides to leave the company, if the company is in liquidation, or if you are at any time considering going public.
You also need to define how you distribute the company’s profits. This is usually done based on the contributions or percentages, but it is important to have this in writing before the company starts making money. This is not a topic you would like to have confusion on.
You must document the percentage of ownership each member has. If you are a single LLC, you will be the sole owner when you first sign your operating agreement.
If you are a multi-partner LLC, each member has a percentage of ownership that will dictate profits and shares in the future. This is usually based on what they have contributed in terms of capital or services to the company.
Then determine the management structure. LLCs are usually either member-managed or manager-managed. You need to document which of these your LLC will follow and if you appoint managers, how much they will be paid.
You must also clearly define each member’s roles and responsibilities and any managers hired.
Then you need to determine the formal procedure for adding new members in the future. This may include the process of onboarding, rules to be followed, or any reason for immediate dismissal.
You need to document how decisions will be made in your LLC, through codification of meeting procedures. This includes:
Voting rules How the votes are weighed (ownership, percentage, etc.) Voting options Action requirements (unanimous, majority rule, etc.)
You also need to be aware of who is influencing each decision. This can mean that too big decisions, such as Investments, everyone must agree.
Finally, you need to decide what will happen if a member chooses to leave, or in the worst case, die.
You need to clearly define what will happen to their ownership and interests, and whether members who leave voluntarily should offer other members first right of rejection. If a member dies, document how their interest is paid to other members or their families.
# 5 – Terminate the operating agreement
Once you have followed the above steps and all the members have agreed on everything, you can complete your operating agreement.
In most cases, this remains an internal document for your reference.
Here are the last few steps you need to take to file it properly and make it official:
Sign it – When everything is correct and agreed, all members must sign. If you are a single LLC, still need to add your signature. You should also have a lawyer or a registered agent see this and read the document to make sure there are no discrepancies. Submit it to the state – If you live in a locality or in a state that requires you to have an operating agreement, this is the point where you send a copy to them. You can ask your registered agent, education service or a lawyer to help you with this. File it internally – Even if you live in a state that does not require an operating agreement, it is still really important to make copies and archive them in a safe place, preferably digitally.
The point of an operating agreement is that it is a fluid document that can be changed over time. You must have copies available to change in the future, show to investors or possibly deliver to the courts.
In a multi-partner LLC, it is also best practice for each member to have their own copy.
Operating agreements are the most exciting part of starting a business, but they keep you organized and avoid communication problems between members. Once completed, you can change your operating agreement with any changes to details or policies. Remember, it’s a floating document.
When you are done, you can move on to other, more exciting parts of developing a business. If you are ready to start marketing your business, see our branding guide. Or learn more about how the right content marketing strategy can skyrocket your business here.