Thursday, April 3, 2008

What Goes Into An LLC Operating Agreement?

A limited liability company (LLC) is formed by filing articles of organization with a state that issues the charter. The articles are very basic. An LLC operating agreement is an agreement between the members (i.e., owners) of the LLC giving the operational details of the organization. Here is a survey for each state listing whether an operating agreement is required and, also, whether the LLC operating agreement must be in writing.

So your LLC has been formed. You've decided you wish to have a written operating agreement and, now, are faced with determining exactly what goes into the agreement. Let's start with the basic elements.
  • Name all the members.
  • List the initial capital contribution required by each member.
  • List what services, if any, are to be provided by each member
  • Allocation of profits and losses.
As to the initial capital contribution, the best course of action is to state specifically when the contribution must be made by the members and the penalty for failure to make the payment. Same with services: what is the penalty if a member fails to deliver the promised services? Lastly, the all important issue of profits and losses. Most LLC operating agreements state percentages of ownership for each member (sometimes expressed in units) with profits and losses divided according to ownership interest. But this is not required. When profits and losses of an LLC are not allocated based upon the ownership percentage, it is called a "special allocation". Corporations may not make special allocations of profits and losses while partnerships and LLCs can. However, special allocations must meet the substantial economic effect test set forth in IRS regulations. Get advice from a tax professional before attempting a special allocation.

Other recommended topics to be covered in an LLC operating include the following:
  • Expulsion of a member.
  • Admission of a new member.
  • Withdrawal of a member.
  • Death of a member.
  • How LLC member voting is conducted.
  • When the LLC is managed by managers, what matters are reserved for decision by the members.
  • Restrictions upon sale of LLC interests to persons outside of the current ownership group.
  • Restrictions upon LLC members participating in competing business ventures.
The list of topics that can go into an LLC operating agreement is quite expansive but, hopefully, the foregoing has covered the most common topics.

Sample LLC operating agreements:

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