So you are starting an LLC, and somebody told you that you need an operating agreement. What goes into that? That's what we're going to talk about today.
What I want to talk to you about is your operating agreement. By the way, if you're not sure what an operating agreement is or what it does, I've got a link up here to four mistakes that entrepreneurs make when they're forming their LLC. Not having an operating agreement is one of them, and we talk to you about why that is in that video, so check that out.
An operating agreement does a lot of things. Basically what it is, is a contract between you as the business owner, if you're a single member LLC, or your business partners, if you are a multi-member LLC, about how the business is going to be run, different things that you're going to do. We're going to talk about all that here today, what goes in the operating agreement. It's basically the backbone of your business. It's the foundational document that is going to talk about everything that you need to know about how to run and operate your LLC. Make sense?
Also does a huge thing, is it keeps people from piercing the corporate veil. If you've got an operating agreement in place and you can show that you've been following the operating agreement, then if you ever were to get sued, then it's going to keep people from going through your business to try and get at your personal assets. That's one of the reasons we start an LLC. It's called a limited liability company for a reason. You're trying to limit your liability in the event something goes wrong with the business.
1st Section of the Operating Agreement – Preliminary Information
So let's talk about what goes into an operating agreement. The first section you want to have in your operating agreement is just a preliminary section. It's going to have a name, your name, the name of the business, the purpose of the business, who the registered agent is, what your address is, what state are you forming the business in, and all those type of things are going to go into this initial section of the operating agreement.
2nd Section of the Operating Agreement – Management Information
The next section of the agreement is going to talk about how the business is going to be managed. And by managed, I mean is it going to be member managed or is it going to be manager managed? There's differences between those two. So that's the second section. You need to make a decision about that. A lot of people make mistakes when it comes to deciding how they want to manage their business and whether it's going to be one or the other, and they just go and file their corporate paperwork and don't really think anything of that, but it is an important decision. If you did the wrong thing, if you made a mistake, don't worry you can change that later. Not a huge deal. But that's just something you want to be aware of when you're drafting your operating agreement.
3rd Section of the Operating Agreement – Member Information
Next section is who are the members of the LLC. You're going to have a list of all the members of the LLC. It might be that it's just you. It might be that there's other people. Whoever it is, you want to have a list and you want to include that in the agreement.
4th Section of the Operating Agreement – Tax Election
Next section of the operating agreement, how is your LLC going to be taxed? You need to make sure you have that information in the agreement. You need to decide that ahead of time, because there are strict deadlines as to when you can make these elections. Hold on one sec. Whether you want to be taxed as just a sole proprietorship, a partnership, an S-Corporation or a C-Corporation, you need to make that election and you need to decide that. You typically include that in the operating agreement. Cool. Make sense? Good.
5th Section of the Operating Agreement – Financial Contribution
The next section of the operating agreement you want to put in there, how much money are you going to contribute? How much money are the other members going to contribute to the LLC? One of the big benefits of an LLC versus other things is your ownership does not necessarily have to be in proportion to how much money you've contributed to the LLC.
With an S-Corporation for example, if you're filing a straight S-Corporation and it's not an LLC, you've got a corporate entity and then you made X selection status, the ownership interest in the corporation, the shareholder interest, has to be in proportion to the amount of money that was contributed. That's not necessarily the case with an LLC. There's a lot of flexibility there in terms of one person could contribute a lot of money and the other person could contribute a lot of sweat equity, and they could be 50-50 members of an LLC, which is a nice benefit to an LLC versus an S-Corporation. That's just an aside.
6th Section of the Operating Agreement – When to Make Contributions
Next section you want to put in there is how and when our contributions and distributions going to be made from the LLC. So how much money are you going to be expected to put into the LLC on a regular basis, or alternatively, how are you going to decide when distributions should be made from the LLC? How are you going to decide how much money you're going to make in a salary versus distributions versus profit, whatever? You want to include something about that in your operating agreement.
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7th Section of the Operating Agreement – Legal “Stuff” You Need
Next you want to include just some general legal provisions in the operating agreement. What type of records are you going to keep? Who are the officers going to be of the LLC? Are you going to vote yourself as a president or a manager or something like that? How often are you going to have meetings for the LLC, annual, quarterly, something else? All that needs to be included in the operating agreement. And then you need to show that you've been actually following that.
8th Section of the Operating Agreement – Can You Change the Agreement
So the last section, well, there's one other section after this, but the last major section is how are you going to make changes or amendments to the operating agreement? You want to include a section in there that talks about how you might make changes to the agreement if something were to happen.
9th Section of the Operating Agreement – Signature Page
And then the final section is going to be signatures. So that's where you and all the other members are going to sign the agreement to say that you basically ratify the agreement, form the LLC, yada yada yada. Also you can include a spousal consent if required by your state, the state where you're filing the LLC. Some states require that, some states don't, so you want to check with your state rules.
The other thing I'll tell you about operating agreements just in general is that with your operating agreement, this is an internal document. This is not going to be filed with your Secretary of State's office. It's going to be completely private. This is something that's only going to be circulated between you and the other members of your LLC if you're a multi-member, or you and yourself, if you are just a single member LLC. That's just important to know, because a lot of people think this needs to be filed somewhere. Some states do require an operating agreement. Other states don't. Where I'm licensed practice in Florida and North Carolina, there's no requirement that you have an operating agreement, but it is good practice and something I definitely recommend.
If you'd like to get a sample agreement that you can start working off of, I actually have one for sale, link up here. Also I'm working on a video that's going to go along with that agreement so that you'll know exactly how to use it when you download it, because that's helpful too. We've got lots of information at LLCs on our channel. That's it for today folks. Have a great day. We'll talk next time. Bye-bye.
