You've formed your US LLC. You have your EIN. Your bank account is set up. But there's one critical document you might be overlooking: the Operating Agreement.
While most states don't legally require an operating agreement, operating without one is risky business. It's like driving without insurance ā you might be fine until something goes wrong.
This guide explains why every LLC needs an operating agreement and what clauses you must include to protect your business.
š Table of Contents
What is an Operating Agreement?
An Operating Agreement is an internal legal document that outlines how your LLC will be run. It's like a rulebook for your business.
Key Purposes
- Defines ownership structure: Who owns what percentage
- Establishes roles: Who makes decisions and how
- Protects limited liability: Keeps business separate from personal
- Prevents disputes: Clear rules for disagreements
- Guides operations: How profits are distributed, meetings held, etc.
Internal Document
Unlike Articles of Organization (filed with the state), your operating agreement is internal. You don't file it with any government agency. It's kept private within your LLC.
Why You Need an Operating Agreement
1. Protects Your Limited Liability Status
Without an operating agreement, courts may "pierce the corporate veil" and treat your LLC like a sole proprietorship, exposing your personal assets to business debts.
Real-World Example
A business owner without an operating agreement was sued. The court found their LLC wasn't properly maintained and ruled it wasn't a separate entity. The owner's personal home and savings were seized to pay the judgment. Cost: $450,000
2. Banks and Investors Require It
When opening business accounts or seeking investment:
- Banks often request your operating agreement
- Investors want to see ownership structure clearly defined
- Lenders need it to verify authorization to borrow
- Payment processors may ask for it during verification
3. Prevents Member Disputes
Clear rules prevent conflicts about:
- How profits are split
- Who can make major decisions
- What happens if someone wants to leave
- How new members are added
- Who handles day-to-day operations
4. Overrides Default State Laws
Without an operating agreement, your LLC is governed by your state's default LLC laws ā which may not align with your intentions.
Example: Most states split profits equally among members by default, regardless of ownership percentage. An operating agreement lets you define custom profit distribution.
5. Establishes Business Legitimacy
An operating agreement shows you're running a real business, not just a shell company for tax avoidance. This matters for:
- IRS audits
- Legal disputes
- Contract negotiations
- Business credibility
Is an Operating Agreement Legally Required?
| State | Required? | Notes |
|---|---|---|
| Wyoming | ā No | Highly recommended |
| Delaware | ā ļø Recommended | Protects liability status |
| California | ā Yes (multi-member) | Must be written |
| New York | ā Yes | All LLCs must have one |
| Missouri | ā Yes | Required for formation |
Bottom Line: Even if your state doesn't require it, you should have one. The protection it provides far outweighs the minimal cost.
10 Essential Clauses Every Operating Agreement Needs
1. Organization & Formation
What to include:
- LLC legal name
- Formation state and date
- Principal business address
- Purpose of the LLC
- Duration (usually "perpetual")
2. Member Information
What to include:
- Names and addresses of all members
- Ownership percentage for each member
- Initial capital contributions
- Type of interest (voting vs non-voting)
3. Management Structure
Define if your LLC is:
- Member-Managed: All members participate in decisions
- Manager-Managed: Designated managers run day-to-day operations
Include:
- Who has authority to make decisions
- What requires unanimous vs majority vote
- Who can sign contracts
- Who manages bank accounts
4. Capital Contributions
What to include:
- Initial contributions from each member (cash, property, services)
- Future capital calls (if more money needed)
- Penalties for not contributing
- How contributions affect ownership percentage
5. Profit & Loss Distribution
Critical to define:
- How profits are split (% to each member)
- When distributions are made (monthly, quarterly, annually)
- Whether distributions match ownership % or differ
- How losses are allocated for tax purposes
- Retained earnings policy
Example: Custom Distribution
Member A owns 60%, Member B owns 40%. But they agree to split profits 50/50 until Member B's initial investment is repaid. This flexibility is only possible with an operating agreement.
6. Voting Rights & Decision-Making
Specify:
- Major decisions requiring vote: Selling the business, taking on debt, hiring key employees
- Voting thresholds: Unanimous, majority, supermajority (75%+)
- Tie-breaking procedures
- Proxy voting rules
7. Member Meetings
What to include:
- How often meetings are held (annual, quarterly, as-needed)
- Notice requirements (7 days, 30 days, etc.)
- Quorum requirements (minimum attendance)
- Virtual meeting allowances
- Meeting minutes requirements
8. Transfer of Membership Interest
Critical protections:
- Restrictions on transfers: Can members sell their stake?
- Right of first refusal: Existing members get first option to buy
- Approval requirements: Do other members must approve new members?
- Valuation method: How to calculate buyout price
- Prohibited transfers: No transfers to competitors, minors, etc.
Why This Matters
Without transfer restrictions, a member could sell their stake to anyone ā including your competitor. Transfer clauses protect your LLC from unwanted new members.
9. Buy-Sell Provisions
What happens when a member:
- Dies
- Becomes disabled
- Gets divorced
- Goes bankrupt
- Wants to quit
- Is expelled
Define:
- Buyout price formula (book value, fair market value, multiple of earnings)
- Payment terms (lump sum, installments)
- Who has the right/obligation to buy
10. Dissolution & Winding Up
Plan for ending the LLC:
- Events triggering dissolution
- Vote required to dissolve (usually unanimous or 75%)
- Process for winding up (paying debts, selling assets)
- Order of distributing remaining assets
- Final tax return responsibilities
Single-Member vs Multi-Member Operating Agreements
Single-Member LLC Operating Agreement
Even solo founders need an operating agreement!
Key differences for single-member:
- No voting or dispute resolution needed
- Simpler profit distribution (100% to you)
- Focus on liability protection
- Succession planning if something happens to you
- Proves separation between personal and business
Why Single-Member LLCs Still Need One
- ā Protects limited liability status in court
- ā Required by banks for business accounts
- ā Strengthens IRS classification as a business entity
- ā Establishes succession plan if you pass away
- ā Shows professionalism to clients and partners
Multi-Member LLC Operating Agreement
Absolutely essential for LLCs with multiple owners.
Additional clauses needed:
- Detailed voting procedures
- Dispute resolution mechanisms
- Deadlock-breaking procedures
- Member removal provisions
- Non-compete and confidentiality clauses
- Management responsibilities
How to Create an Operating Agreement
Option 1: DIY with Templates (Cheapest)
Cost: $0
Time: 2-4 hours
Best For: Simple single-member LLCs
Where to find templates:
- Your state's Secretary of State website
- Your LLC formation service (often included)
š Download Free Operating Agreement Template
Get our state-specific Operating Agreement template delivered to your email.
Template Warnings
- ā ļø Generic templates may not fit your situation
- ā ļø Must be customized for your state's laws
- ā ļø Easy to miss critical clauses
- ā ļø No legal review
Option 2: Online Legal Services (Best Value)
Cost: $99-299
Time: 1-2 hours
Best For: Most LLCs
Services:
- I Love LLC - Professional formation services available
- Customized questionnaire
- State-specific provisions
- Attorney review (some plans)
Option 3: Attorney (Most Protection)
Cost: $500-2,000+
Time: 1-2 weeks
Best For: Complex LLCs, multi-member, raising capital
When to hire an attorney:
- Multiple members with complex arrangements
- Significant capital investment
- Real estate holding companies
- Professional service firms
- Planning to raise VC funding
- High-liability industries
When to Update Your Operating Agreement
Your operating agreement isn't set in stone. Update it when:
- āļø Adding/removing members
- āļø Changing ownership percentages
- āļø Modifying profit distribution
- āļø Switching from member-managed to manager-managed
- āļø Major business changes (new product line, expansion)
- āļø Member marriage/divorce
- āļø State law changes
- āļø Annual review (good practice to review yearly)
Amendment Process
Include an "Amendment" clause in your original operating agreement specifying:
- What vote is required to amend (usually unanimous or 75%)
- Written amendment requirement
- Notice requirements to all members
- Where amendments are stored
Operating Agreement Checklist
ā Complete Checklist
- ā LLC name and formation details
- ā Member names and ownership percentages
- ā Management structure (member or manager-managed)
- ā Capital contributions
- ā Profit and loss distribution
- ā Voting rights and procedures
- ā Meeting requirements
- ā Transfer restrictions
- ā Buy-sell provisions
- ā Dissolution procedures
- ā All members sign and date
- ā Store safely (digital copy)
- ā Provide copies to all members
- ā Send copy to accountant/attorney
- ā Schedule annual review
Common Mistakes to Avoid
1. Using Generic Templates Without Customization
Templates need to be customized for your state, industry, and specific situation. Don't just fill in the blanks.
2. Forgetting to Sign
All members must sign. An unsigned operating agreement may not be enforceable.
3. Not Updating When Things Change
Your operating agreement should evolve with your business. Review it annually.
4. Vague Language
Be specific. "Members will split profits fairly" isn't clear. "Members will receive distributions pro-rata to ownership percentages quarterly" is clear.
5. Ignoring State-Specific Requirements
Each state has different laws. Make sure your agreement complies with your formation state.
The Bottom Line
Every LLC needs an operating agreement ā even if your state doesn't require it.
Benefits:
- ā Protects limited liability status
- ā Prevents member disputes
- ā Required by banks and investors
- ā Establishes clear rules
- ā Overrides unfavorable state defaults
- ā Shows business legitimacy
Investment: $0-2,000 (depending on method)
Protection: Potentially millions in avoided liabilities and disputes
Get a Professional Operating Agreement
Our LLC formation packages include:
- ā Custom operating agreement for your state
- ā Attorney-reviewed templates
- ā Single or multi-member options
- ā Free amendments for first year
- ā Digital copy included
Included with all formation packages at no extra cost.