Starting a business is an exciting endeavor, but can also be a complicated process. As your executive team sets up the organization’s management structure, it’s important to draft several documents to ensure you have a solid foundation supporting your work. Those documents include articles of association, bylaws, and an operating agreement.
The operating agreement serves as an outline for your ownership framework and provides details on capital contributions, board member responsibilities, and how management procedures should be conducted. This comprehensive guide breaks down what an operating agreement is, why it is essential, and how to write one.
What is an Operating Agreement?
An operating agreement is a binding legal document that outlines the ownership structure and operational procedures of a limited liability company (LLC). It specifies the various rights and responsibilities of its members. The operating agreement is a vital internal document and, in most cases, is not filed with the state, though some states require LLCs to have one. Note that an operating agreement is distinctly different from a partnership agreement in that a partnership agreement applies to general partnerships (GPs) and limited partnerships only.
The operating agreement creates a legal buffer between the LLC and its directors/owners. This shields members from liability so creditors can’t target them in the event of liquidation. Without an operating agreement, the organization could be defined as a sole proprietorship, which could lead to the business owner’s personal assets being used to pay the organization’s debts. After each party has signed the agreement, it becomes a legally enforceable set of rules that all executives must follow.
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Key Components of an Operating Agreement
The key components of an operating agreement include the following:
1. Ownership and Membership Interests
Many LLCs assign ownership based on the percentage of total capital they invested in the business. The operating agreement should provide a detailed account of the ownership percentages of each member and define their membership interest, including initial contributions and any subsequent investments.
2. Management Structure
LLCs can be set up as member-managed or manager-managed organizations. In member-managed companies, the owners make active decisions regarding the day-to-day operations of the business. If the LLC is manager-managed, then the owner hires or elects a manager to run the business on their behalf.
Specify the management structure in your operating agreement to ensure members and the manager understand their roles and responsibilities.
3. Profit and Loss Distribution
LLC owners also receive shares of the company’s profits and losses, referred to as distributive shares. Typically, each member’s share of profits and losses is proportional to their ownership percentage, but there is flexibility in how these shares are allocated. Spell out whatever arrangement your organization chooses in the operating agreement.
4. Voting Rights and Procedures
Another business aspect that needs to be cleared up in the operating agreement is your organization’s voting methods. The document should declare each member’s voting share, if the board requires a simple majority or a unanimous vote to finalize decisions, and how amendments can be implemented to the operating agreement.
5. Roles and Responsibilities
The roles and responsibilities of each LLC member (and manager if you opt for a manager-managed setup) should be outlined clearly so each party knows what the organization requires of them and what authority they have over others. This section should specify day-to-day duties, decision-making powers, and accountability measures for members and managers. It may also include guidelines for hiring employees, handling business finances, signing contracts, and other operational tasks, ensuring everyone understands their obligations and limits within the company structure.
6. Capital Contributions
Capital contributions represent the amount of resources an owner or member puts into the LLC. You can use this section to list each member’s contributions and explain what should happen if members want to withdraw their contributions or ownership in the company and whether the company can require additional contributions in the future.
7. Dissolution and Exit Strategy
Lastly, the operating agreement should cover the possibility that LLC members may decide to end the company one day. Most companies agree that all members must vote to instigate any dissolution process. To dissolve an LLC, the company must submit the required paperwork, liquidate its assets, and pay off any debts. There must also be procedures in place to divide any remaining assets among members.
Operating Agreement Template
Here is a simple template for an operating agreement. While you can use this to guide the draft process, remember to consult with legal professionals to confirm your agreement is compliant with local laws and current regulations.
Operating Agreement of [LLC Name]
This Operating Agreement (“Agreement”) is entered into as of [Date] by and among the following members (collectively, “Members”) of [LLC Name], a Limited Liability Company (“LLC”) formed in the State of [State]:
- Formation
The LLC was formed on [Formation Date] by filing Articles of Organization with the Secretary of State of [State].
- Principal Office
The principal office of the LLC is located at [Address].
- Purpose
The purpose of the LLC is to engage in any lawful business activity as permitted under the laws of the State of [State].
- Ownership
The ownership interests of each Member are as follows:
- Member Name: [Percentage]%
- Member Name: [Percentage]%
- Capital Contributions
Each Member has contributed the following initial capital to the LLC:
- Member Name: $[Amount]
- Member Name: $[Amount]
Additional contributions, if required, will be made as agreed upon by all Members.
- Profit and Loss Allocation
Profits and losses of the LLC will be distributed to the Members in proportion to their ownership percentages, unless otherwise agreed upon by all Members in writing.
- Management of the LLC
The LLC will be [Member-Managed / Manager-Managed]
- If **Member-Managed**, all Members have equal authority to make decisions regarding the operations of the LLC.
- If **Manager-Managed**, the following individual(s) is/are appointed as the Manager(s):
- Manager Name
- Voting Rights
Each Member has voting power in proportion to their ownership interest. Decisions will be made by a majority vote of the Members unless a greater percentage is required by law or this Agreement.
- Distributions
The LLC will make distributions to the Members at such times and in such amounts as determined by the Members in accordance with their ownership interests.
- Transfer of Membership Interests
No Member may transfer or sell their interest in the LLC without the consent of all other Members. Upon death, incapacity, or withdrawal, the remaining Members have the option to buy out the interest of the departing Member.
- Dissolution
The LLC will be dissolved upon the occurrence of any of the following events:
- Unanimous consent of the Members;
- The sale or liquidation of all assets of the LLC;
- A decree of judicial dissolution;
- Any other event causing dissolution under state law.
Upon dissolution, the assets of the LLC will be liquidated, and any remaining proceeds will be distributed to the Members according to their ownership interests.
- Governing Law
This Agreement will be governed by and construed in accordance with the laws of the State of [State].
- Amendments
This Agreement may be amended or modified only by a written agreement signed by all Members.
Signatures
By signing below, the Members agree to the terms and conditions of this Operating Agreement.
—
**Member Name**: _____________________
**Signature**: _________________________
**Date**: _____________________________
—
**Member Name**: _____________________
**Signature**: _________________________
**Date**: _____________________________
—
**Manager Name (if applicable)**: _____________________
**Signature**: _________________________
**Date**: _____________________________
Getting Started With OnBoard
An operating agreement outlines an LLC’s structure, including ownership, management structure, capital contributions, and member contributions. Writing an operating agreement requires outlining ownership, defining ownership rights and compensation, and defining the dissolution terms.
As technology continues to play a crucial role in overall business processes and management, many companies are exploring different ways of using it to improve their operations and corporate governance framework.
OnBoard, a purpose-built board portal platform, comes equipped with enterprise-grade document storage to house your operating agreement and other crucial business documents, like your partnership agreement and LLC annual report. Additional features include:
- Chat and video conferencing capabilities so board members can move more quickly, operate more effectively, and accomplish more — from anywhere.
- Surveys to collect opinions or preferences from the board.
- Personalized homepage that includes upcoming meetings, with instant one-touch access to supplementary materials and announcements.
To find a board platform that includes the features that matter the most to your operations, check out our free Board Management Software Buyer’s Guide.
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About The Author
- Josh Palmer serves as OnBoard's Head of Content. An experienced content creator, his previous roles have spanned numerous industries including B2C and B2B home improvement, healthcare, and software-as-a-service (SaaS). An Indianapolis native and graduate of Indiana University, Palmer currently resides in Fishers, Ind.
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