An operating agreement is essential if you're forming a limited liability corporation (LLC). An LLC operating agreement, also referred to as an LLC agreement, establishes the business' financial and managerial duties, including rules, regulations, and provisions. In short, it governs the internal operations of the company.
As an LLC, the operating agreement addresses various issues typically governed by the law that enables LLCs in the jurisdiction of formation. In addition, these laws include provisions that protect members from personal liability for the business's debts.
Only California, Delaware, Maine, Missouri, and New York require an LLC agreement. Even though Pennsylvania has no requirements, if you're forming an LLC in the Commonwealth, it remains a worthwhile consideration during business formation.
It's best to talk with a business lawyer near you to ensure you create a sound operating agreement.
Basic Provisions of an LLC Agreement
At the very least, an LLC agreement should cover some essential elements:
- The name of the LLC, including the address.
- A statement of intent indicating the agreement is by state laws.
- The business purpose, including its nature.
- The term generally shows that the business will continue until terminated or dissolved.
- Treatment of taxes
- How new members acquire a business interest
Other Items Covered by an LLC Operating Agreement
An LLC operating agreement is generally brief, ranging from five to 25 pages. But it presses owners and members to agree on financial and operational arrangements.
The main goal of the operating agreement is to name members of the LLC and their percentage of ownership. Apart from that, most LLC operating agreements cover six critical sections:
- Ownership: Who owns the business, and what is their percentage of ownership?
- Management and voting: Does each member have a single vote, or is voting based on the percentage of ownership?
- Capital contributions of members: Is ownership based on the capital contributions of the members?
- Membership: What happens if a member elects to leave the LLC?
- Distributions: How will the organization share profits and losses? For example, if a member owns 25% of the business, will they receive 25% of the profits and losses?
- Dissolution: What happens if your business dissolves? Who is responsible for liabilities, and how will assets get dispersed?
Although these areas represent primary considerations, your agreement can cover additional areas such as business decision-making, selling interests, right of refusal, dispute resolution, meetings and meeting protocols, and more. Many also consider forming an LLC for an investment property portfolio.
Why is an Operating Agreement Important?
At the very least, an LLC agreement provides proof of ownership for banks and investors.
More importantly, they help prevent future conflicts and disagreements about significant business decisions because the contract covers terms around most major functions and opportunities.
That's critical. For example, even if you feel you've already come to verbal agreements with co-owning members, misunderstanding may arise as years pass or complications occur. By having terms outlined upfront, you eliminate future conflict.
An LLC operating agreement also protects your company's status as a limited liability structure. Otherwise, your LLC might resemble a sole proprietorship or partnership. And that opens the door to personal liabilities for members.
Overriding State Rules for LLC Operation
Moreover, your state's default rules for how an LLC operates apply without an operating agreement. For example, every state has laws on LCC management, admitting new members, dissolution, and other aspects of governance.
Unfortunately, those rules focus on applying the least common denominator, leading to unwanted results. For instance, your state may, upon your death, default your business to a spouse or child.
However, if you want someone else to assume responsibility for your company following your death, your operating agreement needs to state that. You can override Pennsylvania's default rules by having an LLC operating agreement.
Do I Need a Business Lawyer to Draft the Agreement?
Thanks to the internet, free templates are available to draft an LLC operating agreement. Indeed, here's a resource for creating a PA operating agreement. But remember that the LLC agreement governs your company and its members, so it requires careful consideration.
At the very least, if you want to draft your agreement, take the time to run it by a business lawyer for potential issues. Or better still, have an experienced business lawyer draft a contract for your review. And make sure that the lawyer is familiar with Pennsylvania law.
Need Some Help Drafting an Agreement?
Ultimately, you should construct an LLC agreement to the needs of each unique business. Agreements should comply with the laws of the state where the company operates.
If you're forming an LLC or are already operating a company and need help drafting an LLC operating agreement, get in touch with our local law offices in Bucks County, PA, Montgomery County, PA, and Camden County, NJ.
Our business lawyers can support you with business formation and operating agreement creation. Our law firm can also help you with various other legal concerns, including workers' compensation, employment law, and real estate.
The information above is general: we recommend you consult an attorney regarding your circumstances. This information does not represent legal advice or a substitute for legal representation.