When you’re forming a limited liability company (LLC) with family, friends, or like-minded individuals, it’s easy to get caught up in the excitement of it all. You have to remember one thing — you’re business partners now. When you’re in business together, having ground rules and frameworks that you and your tribe must follow to keep the business going. The first step in doing this is your operating agreement.
1. What is an operating agreement?
Your operating agreement is a document that outlines your financial and functional decisions including the powers, rights, duties, liabilities, and obligations of all the members of your LLC. The operating agreement is typically a contractual document, that brings clarity to the rules and operations of the group business or investor group.
2. Is it mandatory to draft an operating agreement?
While an operating agreement is only required in some states, it’s a best practice to have one. Once you set up an operating agreement, all members of your LLC must sign it making it a binding set of rules for your entire organization. The reason it’s important to have an operating agreement is because it protects the status of the company, especially in times of conflict, and ensures that the business carries on despite any issues. This also mitigates any personal liability for members.
Please note that if you’re in California, Missouri, Delaware, or New York, an operating agreement is a mandatory requirement.
3. What happens if I don’t have an operating agreement in place?
Each state outlines generic rules that apply to businesses in the absence of an operating agreement. Here’s an example of why you want to avoid this. If a state’s generic rules indicate that all profits must be evenly distributed among all LLC members, then your business will be forced to do so regardless of your capital table distribution. If you had an operating agreement in place, this would never come up and you could abide by the terms outlined and agreed upon by your LLC members.
4. What should I put into my operating agreement?
Here are some of the core components to consider adding into your agreement:
- Ownership. You’ll want to clearly outline each member’s ownership in the business as a percentage of the business. Remember, when you add new members, you’re going to need to revise this.
New member inclusion process: It’s important for you to outline how a new member can be added to your LLC and who must approve their inclusion. Beyond that, when a new member is added, ownership comes into play as well. You must determine how your capital table changes and if ownership will shift as a result of this new member.
- Responsibilities, Duties, & Powers of Members & Managers. Members and managers of an LLC will be granted with certain duties and responsibilities to the LLC as well as its members. Dependent upon your LLC setup, these are outlined in management clauses to give different managers different powers. You’ll want to outline everything from day to day operations authority, fiduciary, marketing, etc.
Member-Managed: All of the members can exercise control and certain operations and buying decisions will require a vote from its members decisions.
Manager-Managed: One member is designated control of the LLC in this scenario and members vote only on a few key decisions such as dissolving the LLC, replacing managers if previous ones have resigned, raising capital investments, and admitting new members.
- Profit & Loss Allocation. It’s imperative you identify how your profit and loss allocation is carried out among your members. Typically, these allocations will be in line with the members’ percentage interest in the LLC.
If you’re sued and your operating agreement doesn’t give you discretion, you will be forced to distribute all your profits on an annual basis.
- Meetings & Voting. An LLC operating agreement should outline your voting rules for instance, are voting rights based on ownership percentage? Everything from whether you will conclude a meeting by making a motion to adjourn or casting all ballots in-person during a meeting should be outlined in this section. You’ll also want to identify what constitutes a quorum in order to avoid decisions being made by a small group of members and managers.
- Management. The operating agreement should outline which management decisions will be made by the managers vs. the decisions that require the vote of all managers.
- Buyout and Buy-Sell Provisions. This provision is important in the event a member chooses to leave the LLC or passes away. You’ll want to know what happens to their ownership and the procedures to transfer interest.
5. Is there a template I can follow for my operating agreement?
Now, we know there are many options out there to form an LLC and create an operating agreement. Since you’re here, we’re just going to take a minute to tell you about how to do all of this with Tribevest.
The operating agreement is core to a successful investor group or any partnership and setting appropriate rules and expectations is important to do upfront. With Tribevest, you’ll receive an attorney reviewed template to help you complete your first draft of your Operating Agreement in Tribevest to be filed in any of the 50 states in less than 5-10 minutes. We step you through the determinations important to your business so you can choose which rules are best for your group. You’ll have a first draft configured in less than 10 minutes and ready to collaborate with your business partners.