LLC Operating Agreement: Why You Need One and What to Include

What Is an LLC Operating Agreement?

An LLC operating agreement is an internal legal document that governs how your limited liability company is managed and operated. It defines the rights, responsibilities, and obligations of the LLC's members, establishes how profits and losses are distributed, outlines management structure, and provides procedures for resolving disputes, admitting new members, and dissolving the company.

Think of it as the rulebook for your LLC. While the Articles of Organization filed with the state create your LLC, the operating agreement defines how it actually works.

Why You Need an Operating Agreement

It Is Required by Law in Some States

Several states legally require LLCs to adopt an operating agreement. These include:

New York - Requires all LLCs to have a written operating agreement

California - Requires all LLCs to have a written operating agreement

Missouri - Requires an operating agreement (written or oral)

Maine - Requires all LLCs to adopt an operating agreement

Delaware - While not required to be in writing, Delaware's LLC Act is built around the operating agreement as the primary governing document

Even in states where it is not technically required, having a written operating agreement is strongly recommended for every LLC.

It Protects Your Limited Liability Status

Without an operating agreement, a court could determine that your LLC is not operating as a legitimate business entity, potentially "piercing the veil" and holding members personally liable for business debts. An operating agreement demonstrates that your LLC is properly structured and operated as a separate legal entity.

It Prevents State Default Rules from Controlling

Every state has default LLC rules that apply when members have not agreed on specific terms. These default rules may not align with what you and your co-members actually want. For example, most state default rules provide for equal profit sharing among members, regardless of how much each member contributed. An operating agreement lets you override these defaults with your own arrangements.

It Resolves Disputes Before They Happen

By clearly documenting how decisions are made, how profits are shared, and what happens when a member wants to leave, an operating agreement prevents many common disputes from escalating into costly legal battles.

Single-Member LLCs Need One Too

Many solo business owners assume they do not need an operating agreement because they are the only member. This is a mistake. A single-member LLC operating agreement reinforces the separation between you and your business, which is critical for maintaining liability protection. It also establishes clear procedures for what happens if you become incapacitated or pass away.

Essential Provisions to Include

Ownership and Capital Contributions

This section should clearly document:

**Each member's ownership percentage** in the LLC

**Initial capital contributions** made by each member (cash, property, or services)

**Future capital contribution obligations** and what happens if a member fails to contribute

**How additional capital needs will be handled** (additional contributions, loans, or new members)

Management Structure

LLCs can be either member-managed or manager-managed. Your operating agreement should specify:

**Whether the LLC is member-managed or manager-managed**

**Who has authority to make day-to-day business decisions**

**Which decisions require a member vote** (such as selling assets, taking on debt, or entering major contracts)

Voting thresholds - Whether decisions require a simple majority, supermajority, or unanimous consent

**How managers are appointed and removed** (if manager-managed)

Profit and Loss Distribution

This section defines the economic deal between members:

**How profits and losses are allocated** among members (which may differ from ownership percentages)

**When and how distributions are made** (monthly, quarterly, annually, or at the manager's discretion)

**Guaranteed payments** to members who actively work in the business

**Priority distributions** or preferred returns for certain members

Transfer of Membership Interests

Controlling who can become a member is critical for many businesses:

**Restrictions on transferring membership interests** (right of first refusal, approval requirements)

**How membership interests are valued** for purposes of buyouts or transfers

**What happens when a member wants to sell** their interest

**Buy-sell provisions** triggered by specific events (death, disability, divorce, bankruptcy)

Admission of New Members

Your operating agreement should address:

**The process for admitting new members**

**What vote is required** to approve a new member

**Capital contribution requirements** for new members

**How the admission of a new member affects existing members' interests**

Member Withdrawal and Dissociation

Situations where a member leaves the LLC must be planned for:

Voluntary withdrawal - Under what conditions a member can leave and what compensation they receive

Involuntary dissociation - Events that trigger a forced departure (bankruptcy, breach of the operating agreement, legal judgment)

Buyout terms - How the departing member's interest is valued and paid for

Non-compete and non-solicitation provisions - Whether a departing member is restricted from competing with the LLC

Dissolution and Winding Up

The operating agreement should specify:

**Events that trigger dissolution** (member vote, specific date, or triggering events)

**The vote required to dissolve** the LLC

**The process for winding up business affairs** and distributing remaining assets

**The order of priority for distributing assets** (creditors first, then return of capital, then profit shares)

Dispute Resolution

Including a dispute resolution mechanism can save significant time and money:

**Mediation as a first step** for resolving disagreements

**Binding arbitration** as an alternative to litigation

**Which state's laws govern** the operating agreement

**Where disputes will be resolved** (jurisdiction and venue)

State-Specific Requirements

Different states have different rules about what an operating agreement must contain:

Delaware - Offers the most flexibility and allows operating agreements to modify or eliminate most default statutory rules

California - Requires specific language regarding the LLC's purpose and member acknowledgments

New York - Requires a written agreement and specifies certain provisions that must be included

Texas - Refers to the operating agreement as a "company agreement" and allows significant flexibility

Regardless of your state's specific requirements, a comprehensive operating agreement protects your business and its members.

Getting Professional Help

While templates and online generators can provide a starting point, a well-drafted operating agreement should be tailored to your specific business, its members, and the state where it is organized. We recommend working with an attorney experienced in LLC law to draft or review your operating agreement.

CLS can help you with entity formation and connect you with the compliance tools you need to keep your LLC running smoothly. Our registered agent services ensure your entity stays in good standing, and our compliance dashboard helps you track all your obligations. Contact us for a free consultation.