5 Things You Need to Include in Your LLC's Operating Agreement

An operating agreement is easily one of a Limited Liability Company’s most important documents. And I’m not the only one who thinks so--the Small Business Administration highly recommends that every new LLC draft an operating agreement. Though only a couple of states, like New York and Missouri, legally require operating agreements, all LLCs should still have one. An operating agreement lays out the rules by which an LLC is run, allowing the LLC’s members to direct the business as they see fit. But when you draft an operating agreement, you have to make sure it covers everything that it should.

What to include in an LLC operating agreement

A comprehensive operating agreement will clarify the following five parts of running the LLC:

1. Ownership

Normally, the ownership of the LLC is divvied up based on initial investment. If you put in 60% of the capital needed to get the LLC started, you own 60 percent of the company. However, there are times when people don’t want the ownership divided this way. For example, if the business is built on your partner’s idea, and you just put in a bit of capital to get the company off the ground, you partner is probably entitled to their fair share of the LLC. Anytime you want to assign ownership of the company disproportional to what a partner invests, you will need to clarify that in your LLC operating agreement.

2. Rights and Responsibilities of Members and Managers

An LLC’s members are typically its owners, but those members can elect a manager to run the company if they don’t want to be as heavily involved in its day-to-day management. Your LLC’s certificate of formation will probably even have a section where you specify whether the company is directed by its member or a manager. However, you still need to specify what the roles and responsibilities of the members and, if you have any, the managers, are while running the company. You should also include a plan to help resolve any disputes between members, or members and managers.

3. Distribution of Profits and Losses

With an LLC, any earnings or losses are passed through the company, directly to the owners. Again, this is normally done according to percent owned, so if one person owns 75 percent of the LLC, they are passed 75 percent of the profits and/or 75 percent of the losses, which they then report on their personal tax return. But there are times when an LLC’s members may want to adjust distribution, like when they are trying to stay within a particular tax bracket.

More articles from AllBusiness.com: 

• 10 Frequently Asked Questions About LLCs
• Pros and Cons of a Limited Liability Company (LLC)
• How to Form an LLC
• 10 Tips for Naming Your Startup Business
• How Do Owners of an LLC or S Corporation Get Paid?

4. How to Change Owners

Most states, by default, will dissolve an LLC if one of the founding members decides to pull out. This can leave the entire company in a state of disrepair, especially if the remaining members want the business to continue. So, if your LLC has multiple owners or members, it’s vital to accommodate potential exits. How will their share of the LLC be distributed? What can they expect in terms of compensation? Do they have to give you any sort of written notice? All of the LLC’s members should discuss the possibility of an early exit so that the LLC isn’t dissolved until every member wants it to be.

5. Dissolving the LLC

When that day comes, you should be able to fall back on the terms of dissolution in your LLC operating agreement. Again, you need to clarify how the LLC’s assets will be divided after its debts are paid, as well as who is entitled to what parts of the LLC. The member that initially came up with the idea for the business, for example, may want to be allowed to continue on their own without having to compete with their ex-partners. No one likes to think about the dissolution of their business, but you have to cover all of your bases. Otherwise, best-case scenario you’re looking at a few months of stress and fighting, and worst-case you’ll be facing down a lawsuit.

An operating agreement might feel like an unneeded formality, especially when you are first starting out. But if you’re opening a business with a partner, or thinking about bringing someone onto the business a bit down the road, you absolutely need an LLC operating agreement to keep the company running smoothly. Plus the state government likes to see LLCs with an operating agreement, as they help the business look like a separate entity, rather than a standard sole-proprietorship or partnership. Operating agreements are well worth the time they take to write so, before you start doing business as an LLC, make sure you have one drawn up and in place.

RELATED: LLCs vs. S Corporations: What’s the Best Business Structure for Your Business?