What Your LLC Operating Agreement Should Say

Every successful business starts with a clear set of rules that define how the company and its owners will operate. For LLCs, this means having a strong Operating Agreement. Whether you’re an entrepreneur in Colorado, Kansas, Missouri, or elsewhere, this guide is for you.

Your LLC Operating Agreement is more than just a formality—it sets the stage for how your business runs, how decisions are made, and how potential conflicts are resolved. Below, I’ve outlined the most crucial elements to include in your Operating Agreement.

Defining Ownership

First things first, determine who owns your company. LLC owners are known as members (not shareholders). Your Operating Agreement should clearly list all members, either directly in the agreement or in an exhibit, like a membership list or cap table.

Adding and Removing Members

How will you handle new members or the departure of existing ones? Decide how new owners can be admitted, if and how owners can withdraw, and what happens if a member becomes incapacitated or passes away. Clarity here can help avoid messy disputes later.

Member Contributions

Document what each member is contributing to the company in exchange for their ownership stake. Contributions can include cash, property, services, or a mix of these. Make sure everyone’s contributions are recorded clearly.

How to Split Equity Fairly

Fairness is key when determining how equity is split. Consider each member’s contribution, their responsibilities, and overall fairness to avoid conflicts. Remember, many businesses fail due to disputes among owners—a well-thought-out equity split can prevent this.

Need help with equity splits? Check out my guide on fair equity distribution.

Ownership Transfers: Rules and Exceptions

To protect the integrity of your company, consider including rules around ownership transfers. You might want to prevent a member from selling or transferring their interest without approval from the others. Also, outline permitted transfers, such as Rights of First Refusal, Drag Along Rights, Tag Along Rights, and estate planning transfers. These details can protect the interests of all members.

Voting Rights and Decision-Making

Different decisions might need different voting thresholds. Establish what voting rights each member has, and decide which types of decisions require a majority vote, super majority, or unanimous consent. This way, everyone knows what it takes to make major business decisions.

Management Structure

Will your LLC be member-managed or manager-managed? In a member-managed LLC, each member can sign contracts and make decisions, while in a manager-managed LLC, only designated managers have these powers. Typically, designating the LLC as manager-managed is a good move, as it can help streamline operations. Be sure to outline any limits on the manager’s power in your Operating Agreement.

Intellectual Property Ownership

If you want the company to own all intellectual property created by its members, make that explicit. Alternatively, if there’s a shared ownership or licensing agreement, detail it here. Sometimes, these terms may also be part of employment or other agreements. (Related Guide: Intellectual Property 101)

Confidentiality and Business Restrictions

Protect your business by including confidentiality obligations. Prevent members from disclosing sensitive company information to outsiders. You may also want to restrict members from owning stakes in businesses that directly compete with your LLC. (Related Guide: An Intro to Non-Disclosure Agreements)

Taxation Choices

LLCs have flexibility when it comes to taxation. Decide how your LLC will be taxed—whether as a sole proprietorship, partnership, or corporation—and include those provisions. (Related Guide: How the IRS Taxes Businesses & Owners)

Guaranteed Payments for Members

If your LLC is taxed as a partnership, consider if any members should receive Guaranteed Payments, which are similar to a salary. These payments can help members meet their own financial needs while the business grows.

Profits, Distributions, and Dividends

Define how profits and other distributions will be handled. For pass-through entities, you may decide to make profit distributions optional but make tax distributions mandatory—ensuring members can cover their tax obligations on income.

Your LLC Operating Agreement is the backbone of your business’s structure and success. The more clearly you lay out expectations, roles, and procedures now, the fewer challenges you’ll face as your company grows.

(This article is general in nature and is not legal advice.)