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Steps for Designing an Operating Agreement
This guide breaks down standard sections and provides sample language for each to help you navigate.
1. Name and Purpose of your LLC
By now, you should have chosen your LLC's name—it's the moniker you registered when you filed your LLC formation documentation. The purpose of your LLC is another aspect you need to address. Keep things general here. This approach allows you to explore new opportunities down the road without having to re-register your LLC.
OPERATING AGREEMENT of [COMPANY NAME]
This operating agreement is adopted as of [Date] (the “Effective Date”), by [Member’s Name], an individual and the sole member (the “Member”) of [Company Name] (the “Company”).
The Member hereby adopts this agreement as the operating agreement of the Company, which agreement sets forth the entire understanding of the Member regarding its subject matter and supersedes all prior understandings and agreements regarding its subject matter.
The purpose of the Company is [Company Purpose], and the conduct of other activities as may be necessary or appropriate to promote the stated purposes, and to engage in any other lawful business or activity for which a limited liability company may be organized under the Act.
2. LLC Management - Member or Manager
This section identifies whether your LLC will be member or manager-managed, and it clarifies the rights and responsibilities of each member. Topics covered here include capital contributions, voting rights, and management structure. Although you might be the sole member, this part remains essential for establishing your single-member LLC.
Member-Managed LLC.
The business and affairs of the Company will be managed by the Member. The vote, action, decision, or consent of the Member will constitute a valid decision of the Member and the Company. The Member may appoint one or more officers (including the Member, if the Member is an individual) who will have such powers and authority to act on behalf of the Company granted to them by the Member.
OR
Manager-Managed LLC.
The business and affairs of the Company will be managed by the manager of the Company and any successor thereto appointed by the Member, which manager may also be referred to as the Company’s president (the “Manager”). The initial Manager will be [Manager Name], who will serve until the Manager’s death, removal by the Member (for any reason or no reason), or resignation. The Manager will have the right and authority to manage the affairs of the Company and make decisions and take action with respect thereto without further approval or consent of any kind by the Member. Except as otherwise required by this agreement and in lieu of any limitations set forth in [State Name]’s laws for limited liability companies (the “Act”), the Manager will be solely responsible for and is hereby authorized to manage and operate the business of the Company. Except to the extent that the authority of the Manager is expressly limited by the Member, the vote, action, decision, or consent of the Manager will constitute a valid decision of the Manager and the Company.
3. Registered Agent
A registered agent is responsible for receiving and managing vital documents on behalf of your LLC. You can include this in your operating agreement, but it's not compulsory because your formation documents already list the registered agent.
The Company’s registered agent in State is: Registered Agent Name, Address. The members may designate other registered agents or offices at any time in this state or, if necessary, in other states.
4. LLC Duration
This refers to your LLC's life span or the period it's meant to exist, as outlined in your formation documents. Many business owners opt for their LLCs to last indefinitely, but you also have the choice to specify an exact duration or end date. In Delaware, most LLCs are considered "perpetual" by default, meaning they can exist for as long as needed.
The duration of the Company will be perpetual.
5. Capital Contributions
These are the funds, property, or services you invest in your LLC to get it up and running. For single-member LLCs, capital contributions can come entirely from you as the sole owner. This gives you the flexibility to determine the extent of your initial investment.
It's crucial to document capital contributions properly, providing a transparent overview of your business's financial structure and offering vital data for tax purposes.
The Member’s capital contribution(s) to the capital of the Company for the Member’s membership interest in the Company will be reflected on the books and records of the Company.
OR
The members have made or shall make the contributions of cash, property or services to the LLC as set forth on Exhibit A attached
6. Indemnification
Indemnification provisions act as a safety net, safeguarding your LLC's members from specific costs linked to legal issues that may arise from their work for the company. In short, the LLC covers any legal fees or damages should a member face legal action for their duties within the business.
Clearly define the circumstances under which the LLC will offer this protection and any exceptions in your operating agreement. Note that indemnification typically doesn't cover intentional wrongdoing or severe negligence. Tailoring these terms to suit your particular business risks ensures appropriate protection.
The Member, the Manager, the officers, and the organizer of the Company and their respective affiliates, stockholders, members, managers, directors, officers, partners, employees, agents, trustees, and representatives (individually, an “Indemnitee”) will be indemnified by the Company against any and all losses, claims, damages, liabilities, expenses (including legal fees and expenses), judgments, fines, settlements, and other amounts arising from any and all claims, demands, actions, suits, or proceedings, civil, criminal, administrative, or investigative, in which the Indemnitee may be involved, or threatened to be involved, as a party or otherwise by reason of the Indemnitee’s status as any of the foregoing, which relates to or arises out of the Company or its assets, business, or affairs, if in each of the foregoing cases (A) the Indemnitee acted in good faith and in a manner the Indemnitee believed to be in, or not opposed to, the best interests of the Company, and, with respect to any criminal proceeding, had no reasonable cause to believe the Indemnitee’s conduct was unlawful, and (B) the Indemnitee’s conduct did not constitute gross negligence or willful or wanton misconduct. The termination of any action, suit, or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere, or its equivalent, will not, of itself, create a presumption that the Indemnitee acted in a manner contrary to that specified in clause (A) or (B) above. Any indemnification under this section 5 will be made only out of the assets of the Company, and the Member will not have any personal liability on account thereof.
7. LLC Tax Status
Your Delaware LLC can be taxed as a sole proprietorship, partnership, S corporation, or C corporation, depending on your number of members and selected tax status with the IRS.
Include sections in your operating agreement related to tax status, discussing your chosen classification, how to change it, and how to manage tax returns and allocations (when applicable). This helps your LLC establish a clear plan for handling business finances, encompassing profits, losses, dividends, and taxes.
The Company will be disregarded for federal and state income tax purposes. The admission of one or more additional members, however, will cause the Company to be recognized for tax purposes, and to be taxed, as a partnership.
OR
The Member acknowledges that the Company has elected to be taxed as a corporation for federal tax purposes pursuant to the regulations currently in effect under Section 7701 of the Code, and to be taxed as an electing small business corporation under the provisions of Subchapter S of the Code. Notwithstanding such tax treatment, the Member acknowledges and agrees that the Company will be a limited liability company, for state law purposes, under the provisions of the Act, the Articles of Organization, and this operating agreement.
The Member acknowledges that the Company has filed or will timely file a Form 2553 (Election by a Small Business Corporation) with the Internal Revenue Service and that the election made pursuant to the filing is or will be in force and effect covering all periods since the date of this operating agreement. Except as otherwise provided in this operating agreement, during the term of this operating agreement and the continuation of the Company’s “S” corporation election under Section 1362 of the Internal Revenue Code, no Member shall take any action which would cause the revocation or termination of the Company’s “S” election (under Section 1362(a) of the Internal Revenue Code) and any attempt to take such an action will be null and void and without effect. Without limiting the foregoing, and notwithstanding any provision hereof to the contrary, any transfer or attempt to transfer any membership interest to any of the following will be null, void, and without effect:
(a) a person whose ownership thereof would cause the Company to have a number of Members and assignees of membership interests (shareholders of an “S” corporation) greater than the number permitted by Section 1361(b)(1)(A) of the Internal Revenue Code;
(b) an individual who is not a United States citizen or resident;
(c) a trust (or the trustee thereof) which fails to satisfy the requirements of Section 1361(c)(2)(A) or 1361(d) of the Internal Revenue Code;
(d) a corporation; and
(e)any other entity whose ownership would cause the termination or revocation of the Company’s tax status as an “S” corporation.
8. Profit and Loss Distributions
While this clause may not be crucial for single-member LLCs, it's essential for multi-member LLCs to provide clear guidelines on when and how profit and loss distributions will occur.
As the sole member of the LLC, the Member is entitled to all profits of the LLC and is responsible for all its losses. Profits and losses shall be determined annually and will be allocated to the Member's capital account. Distributions of cash or other assets will be made at such times and in such amounts as deemed appropriate by the Member.
9. Amendments to The Agreement
To change any term in your LLC, simply follow the LLC amendment clause in your operating agreement. The process is much simpler for single-member LLCs. Multi-member LLCs should carefully consider voting percentages and requirements for amending the agreement.
This agreement and the articles of organization of the Company may not be altered, modified, or changed, and no provision of this agreement may be waived, except by an amendment or waiver, as applicable, approved by the Member.
10. Corporate Formalities Waiver
Unlike corporations, LLCs are not usually required to follow corporate formalities. However, not adhering to formalities could risk maintaining your corporate veil. Therefore, it's a good practice to include a waiver of all formalities in your operating agreement.
The failure of the Company or the Member to observe any formalities or requirements relating to the exercise of its powers or management of its business or affairs under this operating agreement or the laws in the state in which the Company is which govern limited liability companies will not be grounds for imposing personal liability on the Member for liabilities of the Company.
11. Dissolution
This section maps out the plan for dissolving your LLC and designates who will maintain control in the event of your death or unforeseen departure.
Upon the occurrence of any event which terminates the continued membership of the Member in the Company, the Company will not be dissolved, and the business of the Company will continue. The Member hereby specifically consents to such continuation of the business of the Company upon any such event. The Member’s legal representative, assignee, or successor will automatically become an assignee of the Member’s interest and will automatically become a substitute Member in place of the withdrawn Member.
12. Effective Date
The effective date is the official "start date" of your operating agreement.
Do I Need to File My Agreement?
Nope! Your operating agreement, unlike your Articles of Organization, is merely an internal document. Just sign it, keep a copy, and make sure it's readily accessible when necessary.
What if I Need to Add Another Member to My LLC Later?
Should your business expand, adding another member down the line is entirely possible. Just adjust your relevant documents according to the new member's agreed-upon terms. You might want to draft a new agreement, as multi-member LLC agreements often differ from single-member ones.