Legal Guide

What Your LLC Operating Agreement Should Say

Every business should have documents that establish the rules under which the company and its owners will operate. For LLCs, this means an Operating Agreement (and for Corporations, this usually means Bylaws and a Shareholder Agreement, which will contain many of the same items listed below).

To help, we’re listing 12 things below that you should consider including in your LLC’s Operating Agreement. (Note – this is drafted mainly for LLCs in Kansas and Missouri, but it can help entrepreneurs in just about any state.)

 

1. Ownership

Consider who is, and who is not, an owner of your company. This is usually listed in your Operating Agreement or an exhibit (like a cap table or membership list). Note that owners of an LLC are called members, not shareholders.

 

2. Adding/Removing Owners.

Decide how new owners may be admitted, whether owners can withdrawal, whether owners can be expelled, and what happens if an owners dies or becomes incapacitated.

 

3. Contributions

Determine the contribution each owners is making in exchange for his or her ownership interest. This can be in the form of cash, property, services, or a combination of those.

 

4. Equity Split

Determine how much equity each owner will receive. Consider things like how much they are contributing and what their responsibilities will be. Also consider overall fairness. Most businesses fail due to people problems so you should always aim to be fair with your equity split to avoid arguments later.

Need help splitting equity? Read this guide for more.

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5. Prohibited and Permitted Transfers

Consider adding rules that prohibit an owner from selling or otherwise transferring their ownership interest without some level of consent from the other owners. And related, consider adding some permitted transfers including Rights of First Refusal, Drag Along Rights, Tag Along Rights, estate planning transfers, and optional redemptions following the death of an owner.

 

6. Voting

Establish what voting rights each owner will have and what voting thresholds you’d like to use such as majority vote, super majority vote, and unanimous consent. Different decisions might require different thresholds for approval.

 

7. Management

An LLC can be “member-managed” in which case each member has the power to sign contracts with third parties, or “manager-managed” in which case only designated managers have the power to sign contracts with third parties. It is often best to designed the LLC as “manager-managed” and then to designate one or more managers to oversee the day-to-day operations of the company. The owners can also create limits on the manager’s powers in the Operating Agreement (for example, maybe the manager cannot spend more than a certain amount of money without approval from the members).

 

8. Intellectual Property

If your intent is for the company to own all intellectual property created by the members, then be sure to include a provision stating the same. Alternatively, you can come up with other ownership/license structures if necessary. (Or, you might put this in an employment agreement or similar agreement with the owners.) (Related Guide: Intellectual Property 101)

 

9. Business Restrictions (NDAs and Outside Business)

You should include confidentiality obligations to prevent owners from disclosing the company’s confidential information to third parties. And you might also restrict the owners from owning interests in other businesses that compete with your company. (Related Guide: An Intro to Non-Disclosure Agreements)

 

10. Taxation

Determine how you’ll be taxed and include provisions regarding your decision. This is especially important for LLCs since LLCs can choose how they want to be taxed. (Related Guide: How the IRS Taxes Businesses & Owners)

 

11. Guaranteed Payments

If your LLC is taxed as a partnership (which many LLCs are), decide if any of the members should get Guaranteed Payments (which are more or less like a salary).

 

12. Distributions & Dividends

Be sure to cover how money gets distributed to the owners. If your company is taxed as a pass-through entity, then you might make profit distributions optional and tax distributions mandatory.

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

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