An operating agreement is the code by which Limited Liability Companies (LLC) operate. In many states an operating agreement is not compulsory because in its absence the state law will apply by default. That may not be suitable situation for many LLCs, which require specific provisions for their management.

Though an operating agreement is not required to be in writing, it is prudent to have it properly documented and signed by all members, or by the sole member in the case of a single-member LLC. This will avoid confusion and misunderstandings, and also clarify the limited liability status.

An operating agreement basically covers the rights and responsibilities of members, how the company will be managed, and the manner in which the profits and losses are to be split. Due thought has to be given to such points, because they can have long-term impact on the LLC. Apart from routine details, the major points to be covered in an operating agreement include members’ voting rights, profit sharing, management, meetings, accounts, and span of life.

The voting could be either ‘per capita’ (each member having one vote) or according to percentage of interest the members hold (if a member has 75% of the investment, he carries 75% of the votes). Whether the profits are to be allocated in the pattern of the interest held by each member or according to some other formula should be clearly stated. There is no stipulation in state laws that an LLC should hold annual meetings or draw up reports of accounts, but it is desirable to set out rules about these.

The question of what happens if a member dies or quits has to be considered. It is better that these eventualities are adequately covered with, for example, a buy-out scheme. A clear understanding about the manner in which the members can draw the profits allocated to them is desirable. It is also important to specify how the business will be managed and what responsibilities each member will have.

Software is available to help in drawing up an operating agreement, or a legal expert can be consulted.

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