Essential Tips for a Business Operating Agreement in 2024

When establishing or re-evaluating an LLC for your startup or small business, you need an operating agreement. It forms a blueprint for ownership details, management roles, and profit distributions. The document guides the company’s internal processes, decision-making, and conflict resolution. Our article breaks down the critical elements of an operating agreement, offering actionable insights to ensure your LLC thrives while maintaining legal compliance and operational effectiveness.

• A Limited Liability Company (LLC) operating agreement is a critical, confidential document that structures the LLC’s operations, management, and member interactions, providing a framework for ownership percentages, managerial duties, profit distribution, and procedural rules for company events.
• Customization of the LLC operating agreement is crucial to address the company's unique needs. This includes outlining the management structure, financial protocols, and procedures for handling changes in membership and resolving disputes.
• While an LLC operating agreement is not mandatory in every US state, it is essential for legal protection, clear communication, and operational flexibility. It should be regularly reviewed and updated to reflect business needs and changes.

An LLC operating agreement is a confidential document, a unique blueprint that outlines the procedural and substantive rules for the operations and management of the LLC. Many firms can use a template-based document, but it must be tailored to your (and your partners’) needs. 

The agreement, also known as the LLC’s operating agreement, is the cornerstone of your business, detailing provisions on:

• Members’ ownership percentages
• Managerial powers and duties
• Profit distribution
• Procedures for company events like member admission or buyouts

It strikes a balance between a formal business structure and the need for flexibility to accommodate the particular needs of an LLC. With some 35% of US companies operating as LLCs, it is a common document. One that is mostly needed to resolve issues as these types of companies can grow very fast, founders can move on, or new investors can come on board, or businesses can pivot in different directions.  

Despite its critical role in operational guidance, the LLC operating agreement is a private document, with no requirement to be filed with state agencies, including the Internal Revenue Service, highlighting its primary function in internal affairs.

The LLC operating agreement should include:

• Specific definitions of terms
• The business purpose
• Statement of intent to form a limited liability
• Provisions for handling new members
• The chosen tax classification
• Intended duration of operation
• The LLC’s location

The agreement establishes the basics of an LLC by specifying its name, primary business location, management structure, tax treatment details, member contributions, and contingency plans.

LLCs can be managed by managers (typically the business owners) or members of the business. In a managed LLC, the manager(s) have the authority to make decisions on behalf of the company. Adding or removing an LLC member requires a vote, with voting powers determined by membership interest.

If you plan to run an all-remote business, like Kumospace is, you will require an LLC operating agreement in exactly the same way as a local or national business. Digital nomad businesses can file their LLCs in tax-friendly states like Delaware, but otherwise the process is identical.

An LLC operating agreement is a neutral reference, containing governing principles to help reduce potential disputes. It helps avoid mishandling assets and funds, disputes among members, and extensive, expensive litigation. Reducing disagreements is facilitated by clearly articulating:

• Founder responsibilities
• Member authority
• Financial distributions
• Processes for membership changes

In the agreement, financial institutions play a crucial role in ensuring the stability and growth of the economy by providing essential services to individuals and businesses alike.

The solid operating agreement safeguards the company’s standing and guarantees that operations and management follow the rules established by the members. Though not required by all states, operating agreements are often necessary for interactions with partners, investors, or banks.

If there’s a breach of the LLC operating agreement, you or other parties can take legal action to seek redress or sanctions. If there is a lack of clarity in the agreement leading to uncertainty or arguments, negotiations can take place to clarify it.

If you are drafting your first agreement, there is plenty of advice online or from local business representatives, and a list of basic do’s and don’ts is a good place to start. 

Every LLC is unique, and should have a bespoke operating agreement. A well-crafted LLC operating agreement is tailor-made to suit the specific needs, goals, and operational methods of the LLC. The details ensure the LLC doesn’t default to potentially unsuitable State rules.

The Operating Agreement will specify each member’s ownership percentage and establish various classes of membership that come with different voting rights and responsibilities, often linked to the member’s stake or contributions. An LLC’s management structure can be either member-managed, involving all members in operational decisions, or manager-managed, where a designated manager or group manages daily operations. The operating agreement delineates the process for management decisions, stipulating the kind of approvals required for various decisions, and can include provisions for establishing a board and selecting managers or managing members.

Defining the authorities, appointment procedures, compensation, and fiduciary responsibilities of the LLC’s managers or managing members within the operating agreement is essential.

Given their paramount importance, the financial aspects of an LLC should be clearly delineated in the operating agreement. This includes specifying initial capital contributions by members, which may define their percentage ownership and financial stake in the company. Agreements must include methods for distributing profits and handling losses, with clear rules to govern these financial interactions among members.

Tax considerations, such as election to be taxed as S Corporations and the implications for member contributions and profit distributions, must be clearly articulated within the operating agreement.

Change is inevitable in business, so an operating agreement should be designed to handle changes smoothly. Provisions for adding or removing members, altering capital commitments, and redistributing ownership stakes should be included to accommodate changes in the LLC membership. The operating agreement should detail processes for admitting new members and outline procedures for member sellouts or buyouts.

Procedures for the departure of members, whether voluntary or involuntary, are required to be explicitly laid out within the agreement. The agreement must have the following dispute resolution procedures to handle disagreements among members:

• Negotiations
• Mediation
• Arbitration
• Litigation

An effective LLC operating agreement balances legal protection, clear communication, and flexibility. Single-member LLC operating agreements are typically simpler because a single person holds the power to control. On the contrary, multi-member LLC operating agreements tend to be more complex to address issues arising from shared ownership appropriately.

For multi-member LLCs, operating agreements should clearly outline the rights and responsibilities of each member. Multi-member LLCs require a defined management structure, and protocols for decision-making and resolving disputes within their operating agreements.

An LLC operating agreement shields members from personal liability for the LLC’s obligations and debts by delineating the company as a separate legal entity. The operating agreement is crucial in avoiding risks associated with sole proprietorships by reinforcing the limited liability protection of an LLC. A well-crafted LLC operating agreement helps ensure compliance with corporate formalities, further protecting members from personal liability.

Forming legally compliant business entities via a meticulously constructed operating agreement is key to safeguarding the owner’s interests.

A key part of the operating agreement is a section for indemnity clauses that limit the liability of a party, reducing financial exposure in the event of a loss, damage or specified changes. Hence, the ‘Limited Liability Company’ name.

Clear and efficient communication is the cornerstone of any successful LLC. An LLC Operating Agreement reduces disputes and facilitates decision-making through clear foundational principles and expectations. Platforms like Kumospace support managing team interactions, contributing to the operating agreement’s goal of clear communication.

LLCs can leverage Kumospace to streamline team workflows and uphold agreement integrity, adhering to the guidelines defined in their operating agreement.

An effective LLC operating agreement is adaptable to the changing needs of the business. It can be customized to meet the distinctive requirements of the business, allowing for modification as the company’s needs evolve and promoting growth and transitions. The operating agreement outlines a structure for amendments, enabling the LLC to respond to changes in membership, management, and operation while ensuring ongoing relevance and effectiveness.

The document’s adaptability is showcased when a new member is incorporated into the LLC, a process that requires approval from current members and finalization through an Amended and Restated LLC Operating Agreement.

Whether you’re a single-member LLC or a multi-member one, operating agreements hold vital importance. Single-member LLC operating agreements generally have simpler structures and fewer legal formalities compared to multi-member LLCs.

For multi-member LLCs, operating agreements need to meticulously address matters of individual liability and the distinction between business and personal affairs.

A single-member LLC can utilize a short-form operating agreement due to the single member’s control over operations. In California, a well-drafted operating agreement supports the recognition of a single-member LLC as an independent legal entity, crucial for upholding its limited liability protection.

In a multi-member LLC, it is vital to have a well-defined decision-making process in the operating agreement to guide members when making significant business decisions. Effective management of a multi-member LLC includes:

• Defining clear roles and responsibilities
• Creating a management structure
• Ensuring open communication
• Having a thorough operating agreement

The creation and content of an LLC operating agreement can be influenced by a state’s specific legal statutes and requirements. Georgia does not mandate LLC Operating Agreements, but they are recommended to maintain clarity in business operations and to uphold personal liability protection, especially for single-member LLCs.

Operating agreements in Georgia need not be submitted to the state, as they are maintained internally for record-keeping purposes.

Certain states require that LLCs establish operating agreements; however, this requirement is not consistent across all jurisdictions. States that mandate operating agreements for LLCs include:

• California
• Delaware
• Maine
• Missouri
• New York

New York, Missouri, and California specifically require single-member LLCs to have operating agreements in place.

Customized operating agreements allow LLCs to circumvent broad state default rules that might otherwise govern them in the absence of such an agreement. An operating agreement can override the default rules set by state LLC statutes if it’s properly customized. For an operating agreement to effectively override state default rules, it must be signed by the members of the LLC.

Drafting an LLC operating agreement should include the input from all members to ensure that it accurately represents the agreed terms and structure of the business. State-specific requirements must be taken into account during the drafting phase to ensure that the operating agreement is in compliance with local laws and regulations.

Securing professional services for LLC formation offers benefits including expert guidance on business structure, help with document filing, continual support, and access to resources like sample documents. When choosing a professional service for LLC formation, it is important to consider the cost, level of customer support, experience, and trustworthiness of the provider.

LLC owners, also known as LLC members, can draft an initial version of their operating agreement, which is a legal document, and then seek professional legal advice to refine and complete the document accurately.

The operating agreement should undergo regular reviews and updates to ensure it accurately reflects the current state of the business. The operating agreement must specify a clear process for making amendments, which becomes important as the company grows and evolves.

Once amendments are implemented, it’s imperative to distribute the updated operating agreement to all members, ensuring everyone’s awareness and understanding of the changes.

Crafting a strong LLC operating agreement can be a daunting task, but it is a vital one that can significantly contribute to the successful operation of an LLC. We’ve covered the basics of an operating agreement, its importance, how to customize it, the essential elements of an effective agreement, the difference between single-member and multi-member LLC operating agreements, and how to draft and implement your agreement. By paying attention to these areas, you can create an operating agreement that is robust, comprehensive, and tailored to your LLC’s needs. Remember, a well-crafted operating agreement is not just a legal requirement - it’s a blueprint for your business’s success.