LLC Operating Agreement

An LLC operating agreement is the internal rulebook for your company. It sets ownership stakes, profit splits and management authority. It also says what happens when a member joins, leaves or falls out. Nobody files it. Think of it as a contract that overrides your state's default rules.

Most agreements run 5 to 20 pages, according to the U.S. Small Business Administration. Longer ones exist. A deal with custom profit splits, IP terms or investor classes can stretch well past that. You keep the document with your own business records.

No state asks you to file the agreement with the Secretary of State. But 5 states require you to create one and keep it. Those are California, Delaware, Maine, Missouri and New York. Everywhere else it is optional. Without one your LLC runs on state rules that may not match what you wanted for profits, voting or management.

Formed in California, Delaware, Maine, Missouri or New York? Then yes, by law. New York is the strictest. You must adopt a written agreement within 90 days of filing your Articles of Organization under NY LLC Law § 417. There is no penalty for missing that window. Your LLC simply falls back on state rules instead.

Everywhere else you still need one. Banks ask for a signed agreement before opening a business account. Lenders and investors want proof of who owns and runs the company. And if the LLC is sued, a court may ask whether it is really separate from you.

For a single-member LLC the agreement marks the line between you and the business. That line protects your savings. Skip it and a court can treat the LLC as a sole proprietorship in disguise. Our guide on single-member vs multi-member LLCs covers the structural difference.

A solid agreement covers 8 areas. The exact clauses depend on how complicated your ownership is. These eight apply to every LLC.

• Ownership and capital contributions, each member's investment and their percentage. Also the rules for future capital calls.
• Profit and loss distribution, how income reaches members. Say nothing and most states split it equally.
• Management structure, member-managed or manager-managed, plus who can sign contracts for the company.
• Voting rights, the thresholds for routine and for major decisions. Unanimous consent is common for selling the business.
• Transfer restrictions, whether a member can sell to an outsider, usually with a right of first refusal.
• Buy-sell and succession, what happens on death, divorce, retirement or a member wanting out.
• Dispute resolution, mediation or arbitration before anyone files suit.
• Dissolution, the steps for winding down, paying debts and splitting what is left.

When a member wants out

Most guides list the buy-sell clause and move on. It is the clause founders skip. It is also the clause that decides how the business ends. Here is what the statutes do when your agreement says nothing.

In Delaware you may not be able to quit. Under Del. Code tit. 6 § 18-603, a member can resign only at the time or on the events the LLC agreement names. Say nothing and the default applies. You cannot resign until the company is dissolved and wound up. Where resignation is allowed but the payment terms are missing, § 18-604 gives the leaver the fair value of their interest within a reasonable time.

Leaving is not the same as getting paid. California shows the pattern most states now follow. Under Corporations Code § 17706.03, a member who leaves loses the right to vote and to manage. Their money stake stays put. It becomes theirs solely as a transferee. So a co-founder who walked out in year two still collects a profit share in year nine, and does no work for it. Nothing triggers a buyout unless you wrote one.

Pushing someone out is harder than it looks. Section 17706.02 lets the other members expel a member by unanimous consent in four situations. It is unlawful to carry on with them. They transferred their whole stake away. They are a corporation whose charter was revoked. They are an entity being wound up. A falling out is not on that list. Anything else goes to a judge, who can expel a member for wrongful conduct, for a willful and persistent breach, or where carrying on with them is not reasonably practicable.

Deadlock has a price and a process. Two members hold half each and neither will move. California treats that as grounds to dissolve the company under § 17707.03. The others can stop the dissolution by buying out whoever filed, at fair market value. When nobody agrees on that value, the court appoints three disinterested appraisers to set it. A stranger prices your half. That is the 50/50 trap in one line.

Vesting stops you promising a stake nobody earned. Hand a partner 50 percent on day one and they keep 50 percent if they quit in month three. Vesting fixes that. The stake is granted up front and earned over time, commonly four years with a one year cliff. Leave before the cliff and you leave with nothing. This is the fix for equity promised before any of the work started.

Write the valuation method, not the price. Any number you agree today is wrong in three years. The method survives. Name one, an independent appraisal, book value, or a multiple of earnings, then say who pays the appraiser and how long the buyer has to settle. Buy-sell clauses are often funded with life insurance so a death does not drain the bank account.

A handshake stake still needs paperwork. A relative offering you 51 percent of the family business with no strings is offering you the upside. The exit comes with it, mentioned or not. Write nothing down and your state writes it for you, on the terms above. Northwest Registered Agent puts it plainly on its own free template page, if you go into business with another person the odds are you will eventually part ways, and the operating agreement is what outlines how.

The sections above are California and Delaware law. Every state has its own LLC act. The defaults differ, so read yours or ask a lawyer before relying on any of it. Still deciding how many owners the company should have? Our guide on single-member vs multi-member LLCs covers the trade-off.

For the wider picture on entity choice, read our guide to business entity types.

You have three paths. The right one depends on your budget and how complicated the ownership is.

Path 1, a free template ($0). Northwest Registered Agent gives its LLC operating agreement away as a PDF or a Word file. Some Secretary of State sites post one too. Fill in the LLC name, the members, the percentages and the management structure. That is enough for a single-member LLC. The risk is missing a state provision or the buy-sell clause.

Path 2, an online service ($99 to $199). LegalZoom asks questions about the business and builds the document. The standard version is $99. Rush is $199. Its $249 Pro package bundles the agreement with LLC formation. This is the middle ground for an LLC with 1 to 3 members.

Path 3, an attorney ($200 to $1,000+). A drafted agreement accounts for your state law, your profit split and your member dynamics. Reviews average about $520. Flat fees for a full custom agreement run $500 to $1,500. Lawyers bill $150 to $400 per hour. That is worth paying once outside investors or unusual IP terms are involved.

Then everyone signs and dates it. Keep copies with your business records. Notarizing is not required, though some members do it anyway. If you are still picking a formation service, see our comparison of the best LLC formation services.

The agreement carries no state filing fee, because you never file it. What you pay depends on how you make it.

DIY templates cost $0. Northwest Registered Agent publishes a free operating agreement as a PDF and a Word file. There are single-member, multi-member and manager-managed versions, plus a page for each state. Some Secretary of State sites post one. You fill in the blanks. A general template can still miss your state's provisions.

Online services charge about $99. LegalZoom's standalone agreement is $99. The rush tier is $199. Its $249 Pro formation package includes an agreement alongside the state filing. You answer questions and the service writes the document.

Attorneys charge $200 to $1,000+. A review averages about $520. A full custom agreement usually runs $500 to $1,500 flat. Multiple member classes, IP terms or investor protections can push past $2,000. That still beats a dispute, which can cost $10,000 to $100,000+ in legal fees.

The agreement is one line in your formation budget. State filing fees run $35 to $500. A registered agent service costs $100 to $300 a year.

Only 5 states require an operating agreement. The rest recommend one. Here is how the most searched states handle it.

For formation rules in your state, check the SBA.gov business structure page or your own Secretary of State. Operating outside the state where you formed? Read about foreign LLC registration.

Mistake 1, not having one. In states that do not require it, skipping the agreement hands your LLC to generic rules. Those rules often split profits equally, whatever anyone invested. They also give every member equal say. If that is not what you agreed, write it down.

Mistake 2, using a template as-is. A template is a starting point. Provisions written for another state can clash with your own LLC act. Templates also tend to skip the clauses that matter later, buy-sell, dispute resolution and the tax election.

Mistake 3, skipping the buy-sell clause. A member dies, divorces, goes bankrupt or simply wants out. With no buy-sell provision, your state decides what happens next. It rarely decides in your favor. Name a valuation method and payment terms for each exit.

Mistake 4, vague authority. If the agreement does not say who can sign contracts, open accounts or commit money, any member can. Delaware's default gives every member and manager that power. Write the limits down.

Mistake 5, never updating it. Add a member, change percentages or elect S Corp treatment with IRS Form 2553, and the agreement needs amending. Build the amendment procedure into the original. Otherwise routine changes need everyone's signature.

Mistake 6, forgetting the tax election. The agreement should say how the LLC is taxed and who acts as partnership representative for the IRS. Weighing the S Corp election? Read our LLC vs S Corp comparison. Still need an EIN? Our EIN application guide covers the free route.