An LLC operating agreement is a legally binding contract executed between the members (owners) of a Limited Liability Company. Unlike the Articles of Organization—which is a public document filed with the state—the operating agreement is a private internal document that governs how the LLC actually functions from day to day.
Think of it as the LLC's constitution: it defines the rights of each owner, establishes the rules for governance, and prescribes the procedures for virtually every significant business event from ordinary operations to the eventual dissolution or sale of the company.
The agreement must identify the LLC's legal name exactly as it appears in the Articles of Organization, the state of formation, the LLC's principal office address, and its effective date of formation.
List every member (owner) of the LLC with their full legal name, address, and ownership percentage (expressed as a percentage of total membership interests). This section should also specify the classes of membership interests if multiple classes exist (common in LLCs with investors).
Document the initial capital contribution of each member—the cash, property, or services they contribute in exchange for their membership interest. Specify whether members have any obligation to make additional capital contributions in the future, and under what circumstances.
Establish how profits and losses will be allocated among members. The default in most states is pro-rata allocation based on ownership percentages, but you can customize this—for example, giving certain members a preferred return before regular distributions, or allocating losses to members with higher tax bases.
Define when and how cash distributions will be made to members. Include provisions for minimum tax distributions (ensuring members receive enough to cover their tax liability on allocated income) and restriction on distributions that would render the LLC insolvent.
Specify whether the LLC is member-managed (all members participate in management) or manager-managed (management delegated to one or more designated managers, who may or may not be members). This section should define the scope of management authority—what can managers do independently versus what requires member approval?
Establish voting thresholds for different categories of decisions. A well-drafted agreement distinguishes between ordinary decisions (simple majority), significant decisions (supermajority, e.g., two-thirds), and fundamental decisions (unanimous consent). Examples of fundamental decisions typically requiring unanimity: admitting new members, amending the operating agreement, dissolving the LLC, or engaging in mergers and acquisitions.
Define the fiduciary duties each member owes to the LLC and to fellow members. Most states allow LLC operating agreements to reduce or eliminate certain default fiduciary duties—particularly the duty of loyalty restrictions on competing businesses. If members intend to engage in other business activities, this section must explicitly permit that.
Restrict the ability of members to sell, transfer, gift, or pledge their membership interests without the consent of other members. Include a right of first refusal provision giving remaining members the option to purchase a departing member's interest before it is transferred to a third party.
Establish procedures for voluntary member withdrawal and involuntary dissociation (e.g., due to bankruptcy, death, incapacity, or breach of the operating agreement). Define how the departing member's interest will be valued and purchased by the remaining members.
Define the events that trigger dissolution (unanimous member vote to dissolve, expiration of a specified term, occurrence of a triggering event), the procedures for winding up business affairs, and the priority of asset distribution after paying creditors.
Include a mandatory dispute resolution clause requiring mediation, then arbitration, before any member can pursue litigation. Specify the governing law (the state whose laws govern the agreement) and venue for any proceedings.
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