There are a few things that you need to do when establishing your LLC, and one those things involves coming up with an operating agreement. This is a legal document that establishes how your LLC will be run. So, it will include things like how decisions will be made, how money will be distributed, and how disputes will be resolved, as a few examples. Every member of your LLC will sign the operating agreement and, in doing so, will declare that they’ll follow it closely.
Unlike the necessary articles of organization that you need to file with the government when setting up your business, an operating agreement isn’t required to form your LLC. And, if you do choose to write this agreement, it won’t even be filed with the Secretary of State. Despite the fact that it’s optional, though, an operating agreement is considered a critical component of any LLC with two or more members.
Keep reading for more information on the benefits of having an operating agreement in place, and how to draft one for your business. Please keep in mind that, while we’ve made every effort to ensure this information is accurate, it should not be considered legal advice or a substitute for legal advice. Consult with your attorney if you have any questions regarding operating agreements and any other aspects of your LLC.
The Benefits of Having an LLC Operating Agreement
An operating agreement will govern the relationship between the members of an LLC. For this reason, it’s a great idea to have one if your LLC will have two or more members. If you’re planning on operating a single member LLC, an operating agreement isn’t as important, but you may still choose to create one for yourself to outline the way that you’ll do business.
Here are a few ways that an operating agreement can help:
An LLC operating agreement can help protect your limited liability status. After you’ve received your limited liability status, and the protection of your personal assets that comes along with it, you won’t want to lose it. But it could be lost if it appears as though your LLC isn’t a legitimate business entity that’s separate from you personally.
If you have a written operating agreement in place, it lends credibility to your LLC, further proving to courts that your LLC is indeed a separate entity and not some sham created just to avoid liability. This could be especially important for single member LLCs that can look a lot like a sole proprietorship. The formality of an operating agreement could make all the difference.
Lenders might want to see your operating agreement. When running a business of any kind, you might need to take out loans to cover a variety of expenses. But lenders, as well as other businesses, that hope to work with you in various capacities might want to see an LLC operating agreement before they move forward. If you don’t have a copy of your operating agreement when you attempt to obtain a loan in your LLC’s name, you might be denied.
An operating agreement can override state LLC default rules. Without an operating agreement, your LLC will be solely governed by the provisions of California’s LLC law. Formally known as the California Revised Uniform Limited Liability Company Act (now that’s a mouthful, huh?), this law contains detailed rules about how LLCs in the state should operate. If you don’t have your own operating agreement, you must read this law, which can be found on the California Legislature’s website, so that you can run your business in a way that adheres to the law. And if there are any default provisions that you would prefer not to follow, you don’t really have a choice in the matter.
If you want to run your business differently, you can say so in your written operating agreement, which will override some of the provisions in the California LLC law. Bear in mind that there are certain provisions that you won’t be able to override, even with an operating agreement. Check out California Corporations Code Section 17701.10 to learn about rules that can’t be avoided.
An operating agreement provides a succession plan. Did you know that your operating agreement can also serve as your business succession plan? It’s true. Basically, the agreement should name someone who can manage your LLC in the event that you become incapacitated or die. If tragedy strikes, this could make life a lot easier for your family to legally keep the business going or close it down.
An LLC operating agreement doubles as a useful reference guide. Ultimately, your business’s operating agreement can be a handy guide that you can refer to whenever you need to. It can remind you of how you should be operating your LLC to achieve the most success.
How to Create an LLC Operating Agreement
Right now, you might be thinking, “ugh, another agreement, and more paperwork to add to the pile.” But you can relax, as creating an LLC operating agreement yourself is surprisingly easy.
One option would be to hire a lawyer who can draft your LLC’s operating agreement for you. But, even though this is a great way to have a custom-made operating agreement in place, it could be pricey. Also, keep in mind that finding the right lawyer can be pretty time-consuming. If you take this route, it’s best to hire an attorney who’s really familiar with California’s LLC law, and they should be able to suggest which default provisions in the law you might want to alter.
Thankfully, there’s an easier—and more affordable—way to get an operating agreement in place:
When you create an account with Hyke, we’ll provide you with an operating agreement that has been drafted by a professional attorney. It’s free, and all you have to do is sign it. Done and done!
If you want something that’s catered more to your particular needs, you may want to go beyond a standard operating agreement and draft your own. Or, you can just tweak a standard agreement, such as the one that Hyke provides, in order to customize it so that it can better meet your requirements.
What Exactly Goes into an LLC Operating Agreement?
Now that you know a few of the benefits that you can derive from having an LLC operating agreement in place, you’re likely wondering what this document should contain.
The good news is that you’re free to write your operating agreement in any way that you wish. There aren’t any legal requirements regarding what you must include in the agreement, so that gives you loads of freedom.
Drafting the best operating agreement for your LLC simply means tailoring it to your business’s specific needs. A single member LLC’s operating agreement will typically be shorter and simpler than one for a multi-member LLC. That’s because you won’t need to pay special attention to things like members’ rights and responsibilities.
Despite the freedom that comes with writing your LLC’s operating agreement, there are some key points that are worth including. At a minimum, you should discuss:
1. Ownership – specify if you’re the sole owner and have all the voting rights. Make it clear that you aren’t personally liable for your LLC’s debts and liabilities (always a good idea to emphasize that point).
2. Management – specify how your LLC will be managed. If you’re a small single member LLC, you’ll manage it as the owner of the business. Beyond this, specify who will take your place as the manager if you become incapacitated or die. Keep in mind that an LLC can also be managed by a non-member manager, even though this is rare for a single member LLC. If you do use a manager, define that person’s rights, powers, and responsibilities in that role, and include how the manager will be appointed in the first place.
3. Contributions and Distributions – Specify what property, money, and/or services you’re going to contribute to your business, further proving that your LLC is a legitimate entity. Also, specify how your LLC will distribute profits or losses to you. If you’re a single member LLC, you’ll get 100% of both, and you’ll report it all on your personal tax return. However, if you want to be entitled to draw from the profits of your LLC at will, say so in the agreement (this might be a good strategy if you have problems with creditors in the future).
4. New Members – Even if you establish your LLC with one member (a.k.a. you), you might want to let other members join the business in the future. For this reason, it’s a good idea to have a portion of your operating agreement that’s focused on the procedures that you’ll use when admitting new members.
5. General Provisions – Set forth the general rules regarding how your LLC will be managed. Think: holding meetings, voting, documenting important decisions, etc.
6. Signature – Finally, don’t forget to sign your operating agreement to make it legally binding. As mentioned above, there’s no need to file this agreement with the Secretary of State or any other agency. Just keep it in a safe and secure place with your other LLC records at your principal place of business. Easy peasy!
LLC Operating Agreement: Optional but Worth It
So, there you have it: these are the basics that you should know about an LLC operating agreement. Sure, it’s optional, but it’s a great little document to have in place for added protection and guidance when it comes to running your LLC like a pro.
If you’re ready to take the next step in establishing your business, join Hyke today to get started with everything from naming your LLC, to organizing it, and gaining access to all the necessary forms, including your operating agreement. Once everything’s set in place, you’ll be even more prepared to make your business a success.
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.