The Core Elements of an LLC Operating Agreement

The internal governance of your limited liability company (LLC) is largely going to be established by a contract known as the operating agreement. This is the centerpiece of your business structure and operating rules and must be comprehensive and correct. If you need help with your operating agreement, a Colorado small business lawyer can help. While the exact terms in an operating agreement vary by business, there are some core elements that just about all LLCs need to include.

Equity structure

In this section, you will detail membership interests (often expressed as a percentage); membership classes, if any; the capital account of each member; and the allocation of losses, profits and distributions. Keep in mind that for the capital contributions, you should address whether members will only make capital contributions at the start of joining your business or whether they will be expected to make contributions going forward. Also consider whether contributions are to be made in any other form, such as sweat equity over time or with contribution of intellectual property to the LLC.

Management

An LLC can be managed by its members or a manager. If you’re going to have a manager, this section of the operating agreement addresses who will appoint the manager and other aspects of the manager’s role, including duties and responsibilities. You should also outline the procedures for removing and replacing a manager here.

Voting procedures

The standard rule is that all members will vote in proportion to their percentage interests. However, you can establish a different rule if you wish. You can, for example, withhold the right to vote from a member or an entire member class. Voting rights can also be set based on capital contributions, accounts or commitments. Some managers or members can even be given veto rights or super-majority votes.

Indemnification and liability limits

In this section, you will deal with the manager’s fiduciary duties. Fiduciary duties in the context of LLCs are complex and always evolving.  Be sure to contact a Colorado small business lawyer for help.

Books and records

This is perhaps the most self-explanatory operating agreement section. You will address record-keeping issues here, including the rights of members to inspect the accounting and corporate records of your LLC.

Protections against dilution

These provisions allow members to retain membership interest percentage when the LLC issues interests to new members. Protections may include giving veto rights to members regarding the issuing of new interests; capital call limitations; and pre-emptive rights that allow a member to buy any membership class on offer to retain their current interest.

Transfer restrictions

There are various restrictions on transfer of membership interests that you can include in an operating agreement. These include barring the transfer of management rights when one member is assigning their interest to someone else, requiring membership interest transfer to be approved by other members or by a vote, and what events–such as the death, insolvency, bankruptcy or disability of a member–trigger buyout. The rules and procedures for a buyout should also be spelled out here as well.

Liquidating and dissolving

In this section, you’ll identify what events can trigger the dissolution of the business or who determines when to dissolve your LLC. You’ll also include the procedures for winding down the company and the distribution of company assets in this section.

Depending on your business, goals and the wishes of others involved in your company, you may need more provisions. Since the operating agreement is a “living” document, you will also need to make changes to it as the needs of your business change. Don’t leave anything about the operation of your LLC to chance or question. Contact a Colorado small business lawyer for help drafting an operating agreement for your business or amending your current agreement.