How to Create an Operating Agreement

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When using the limited liability company, or LLC, structure for a business, members generally draft an operating agreement that governs every aspect of the business. Although the majority of states don’t require LLC members -- the owners of the business -- to draft an operating agreement, most companies do it to avoid having state laws apply by default. All members are subject to the agreement, which usually includes clauses on how profits are split, permissible LLC activities and how the business is managed.

Operating Agreements Define Profit and Loss Allocations

One of the goals of an operating agreement is to eliminate confusion and uncertainty in running the business and to avoid the types of disputes among members that are more likely to occur in the absence of a written contract -- especially when it comes to money. This is why LLC operating agreements generally include clauses that clearly delineate how profits and losses are allocated among members. A profit and loss clause is especially helpful when members' allocations are different than their percentage of ownership. For example, you may own 25 percent of an LLC but the operating agreement can legally provide you with 40 percent of business profits for some reason, such as for recruiting most of the company's clients.

How the LLC Is Run

Operating agreements often provide direction on how the LLC is managed, as well as the types of transactions it can engage in. It can outline the management responsibilities of each member and the extent of authority vested in each member to contractually bind the company; it can even prevent members from engaging in risky transactions or investments. If your LLC is run by employee managers rather than members, your operating agreement can include similar clauses that impose similar, or different, duties and obligations of managers.

Member Voting Rights

In the same way that profit and loss allocations need not mirror each member's percentage of ownership in the LLC, member voting rights can also vary. Operating agreements typically address the types of business decisions that require a vote by members, the number of votes required to take action and whether certain LLC interests include voting interests or not. And since members can amend the LLC operating agreement with the requisite number of votes, agreements can include specific procedures, such as requiring a unanimous vote, to make any change to the agreement even if it differs from the number of votes needed for other LLC purposes.

Selling Your LLC Interest

Unless the operating agreement states otherwise, LLC members are generally able to sell their interests in the business to outside investors. If you and other founding members have concerns about unknown investors being able to manage the business in the future, you can draft the operating agreement to restrict future members from having any management authority; this means they obtain the right to profits only. The agreement can also require that new members be voted in before an interest is sold or that current members have the right of first refusal when any LLC member wants to sell her interest in the company.


About the Author

Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.

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