Creating an Operating Agreement

Note: Links to our free templates are at the bottom of this long guide.
Also note: This is not legal advice

Introduction

Definitions

Legal Structure: The form of organization under which a company operates and is recognized by law, such as a corporation, limited liability company, partnership, or sole proprietorship.
Rights and Responsibilities: An individual’s legal entitlements and obligations.
Jurisdiction: The geographical area over which a court or government entity has the authority to make and enforce laws.
Ownership Percentage: The amount of the company held by each member, which determines their share of profits or losses.
Voting Power: The number of votes each member has and how those votes are weighted.
Financial Capital: The initial contributions of each member and any additional investments.
Accounting System: The type of records to be kept, the frequency of financial statements, and the method of accounting.
Reimbursement Terms: When and how members will be paid and reimbursed for expenses.
Taxation Requirements: The type of taxes to be paid and the filing deadlines.
Internal Policies: How decisions are made and how employees must behave.
Amending the Agreement: When it is appropriate to make changes and who has the authority to make them.
Dispute Resolution: A process for resolving any disputes among the members, such as mediation or arbitration.
Dissolution: The process for winding up the business, such as the steps to be taken when a member wants to leave, the procedure for selling the company, and the distribution of assets.
Signatures and Date of Execution: Who must sign the agreement, the date of execution, any applicable laws and regulations, and the process for filing the agreement.

Contents

1. Outlining the purpose and scope of the operating agreement
2. Defining the legal structure of the company
3. Outlining the rights and responsibilities of the members
4. Specifying the desired jurisdiction of the agreement
5. Identifying the members and their roles
6. Listing the names and contact information of all members
7. Clarifying the roles of each member
8. Establishing the authority of each member
9. Determining the management and ownership structure
10. Assigning the members’ ownership percentage
11. Establishing the voting power of each member
12. Specifying who has the authority to make decisions
13. Establishing the company’s financial operations and obligations
14. Establishing the financial capital of the company
15. Setting up the accounting system
16. Specifying the payment and reimbursement terms
17. Defining the taxation requirements
18. Setting out the company’s rules and regulations
19. Outlining the company’s internal policies
20. Determining the procedure for amending the agreement
21. Specifying the rules for hiring employees
22. Providing for dispute resolution
23. Establishing a dispute resolution procedure
24. Designating a dispute resolution facilitator
25. Specifying the terms of arbitration if needed
26. Establishing the terms of dissolution, if needed
27. Outlining the process for winding up the business
28. Specifying the assets to be distributed
29. Establishing any liquidation procedure
30. Listing the necessary signatures and dates of execution
31. Specifying who must sign the agreement
32. Establishing the date of execution
33. Establishing the applicable laws and regulations
34. Setting out the process for filing the agreement

Get started

Outlining the purpose and scope of the operating agreement

• Read over any existing documents related to the company and its formation
• Identify the goals of the company and its members
• Specify what types of activities the operating agreement will cover
• Outline expected roles and responsibilities for each member of the company
• Draft the initial operating agreement
• Have all members of the company review and sign the agreement

Once all members have signed the agreement and it has been finalized, you can move on to the next step of defining the legal structure of the company.

Defining the legal structure of the company

• Research the different types of legal structure available for the company, such as a corporation, limited liability company, or partnership
• Decide which legal structure best suits the company’s purpose and goals
• Draft the legal language that outlines the chosen legal structure in the operating agreement
• Include the legal language in the operating agreement
• You will know when you can check this step off your list when the legal structure has been decided, the language is drafted, and it is included in the operating agreement.

Outlining the rights and responsibilities of the members

• Determine the responsibilities and obligations of each member, such as decision-making authority, information sharing, and voting rights
• List the rights of each member, such as access to company information, distributions of profits and losses, and dispute resolution
• Specify the process for admitting new members, if applicable
• Outline the process for amending the operating agreement
• Detail the process for dissolving the company in the event of a dispute

You’ll know you can check this step off your list and move on to the next when you have listed and specified the rights and responsibilities of all the members of the company.

Specifying the desired jurisdiction of the agreement

• Research the laws of the jurisdiction in which you would like the agreement to be enforced
• Consider the tax implications of the chosen jurisdiction
• Make sure the jurisdiction you have chosen is suitable for the type of business you are running
• When you have chosen the desired jurisdiction, make sure to include it in the Operating Agreement
• Once you have included the desired jurisdiction in the Operating Agreement, you can move on to the next step.

Identifying the members and their roles

• Understand the purpose of the LLC and the roles of each member who will be involved
• Identify each member and their role in the LLC (e.g. Manager, Member, Secretary, etc.)
• Record the roles of each member in the Operating Agreement
• Record the percentage ownership of each member in the Operating Agreement
• Agree on how decisions will be made in the LLC (e.g. unanimous or majority vote)
• Record the decision-making process in the Operating Agreement
• Once these details are agreed upon and recorded, you can move on to the next step of listing the names and contact information of all members.

Listing the names and contact information of all members

• Gather all the names and contact information of the members
• Verify that the contact information for each member is correct and up-to-date
• Record all the names and contact information in the operating agreement
• Once all names and contact information are collected, recorded and verified, you can move on to the next step.

Clarifying the roles of each member

• List out each member’s role(s) in the operating agreement, including their responsibilities and duties
• Make sure that each member has a clear understanding of what their roles and responsibilities are
• Make sure the roles are reasonable and doable for each member
• Make sure the roles are specific enough to give each member clear expectations
• Make sure the roles are general enough to allow each member the flexibility to make decisions
• Make sure the roles are not overlapping or conflicting
• Make sure each member is comfortable with the roles established
• When each member is comfortable with their roles, you can check this step off your list and move on to the next step.

Establishing the authority of each member

• Outline the authority of each member, including the ability to make decisions, sign documents, and represent the LLC
• Make sure to include who has the authority to appoint new members, remove members, and make changes to the operating agreement
• Decide if all members will have equal authority, or if certain members will have more authority than others
• Once the authority of each member has been established, make sure to update the operating agreement with the changes
• All members should sign the updated agreement in order to make it legally binding
• Once all members have signed the agreement, you’ll know that this step has been completed and you can move on to the next step.

Determining the management and ownership structure

• Clearly define the roles and responsibilities of each member of the LLC
• Specify who will be in charge of the day-to-day operations and how decisions will be made
• Establish a procedure for adding and removing members
• Decide how profits and losses will be distributed
• Assess the tax implications of the ownership structure
• You’ll know you can check this off your list when all members are in agreement about the management and ownership structure.

Assigning the members’ ownership percentage

• Determine a fair and reasonable ownership percentage for each member based on their contribution, skills, and potential contribution to the business
• Discuss and negotiate each member’s ownership percentage until all members are in agreement
• Create a document that outlines the ownership percentage of each member, and get each member to sign it
• Once every member has signed the document, you have completed this step and can move on to the next step of establishing the voting power of each member

Establishing the voting power of each member

• Discuss how many votes each member should have and write them down in the operating agreement.
• Take into account the percentage of ownership each member has when deciding on voting power.
• Make sure to specify if a certain percentage of votes is required to make certain decisions.
• Make sure to specify if certain decisions require unanimous agreement from all members.
• Write down the voting power of each member in the operating agreement.
• Make sure that each member has signed the operating agreement.

Once all of the above is completed, you can check this step off your list and move on to the next step.

Specifying who has the authority to make decisions

• List out the roles and responsibilities of each member involved in decision making
• Assign authority to each member based on their roles and responsibilities
• Specify who has the authority to make decisions in the agreement
• When all roles and responsibilities have been specified, the step of specifying who has the authority to make decisions will be complete and you can move on to the next step.

Establishing the company’s financial operations and obligations

• Outline the company’s financial operations, such as how finances will be handled and how revenues and profits will be divided amongst the members
• Establish how the company will handle expenses and losses, and how they will be shared amongst the members
• Set up a system for keeping records of the company’s finances
• Specify how disputes over financial matters will be resolved
• Establish rules for handling changes in the financial operations or obligations of the company
• You will know when this step is completed when a system is established for the company’s financial operations and obligations.

Establishing the financial capital of the company

• Determine the amount of money needed to start the company
• Determine the type of capital needed to start the company (debt or equity)
• Determine the source of the capital (loans, investors, etc.)
• Negotiate the terms of the capital contribution
• Finalize and document the capital contribution agreement

You will know that you are able to move on to the next step when the financial capital of the company has been established and documented in an agreement.

Setting up the accounting system

• Choose an accounting software, such as Quickbooks, Sage or Xero.
• Set up the software with the necessary accounts and categories.
• Enter any opening balances and ensure they match the financial capital established in the previous step.
• Ensure the software accounts are correctly mapped to the financial accounts the company uses.
• Test the software by entering a few transactions.
• When you are confident the software is set up correctly, you can move onto the next step.

Specifying the payment and reimbursement terms

• Identify the payment and reimbursement terms, including how you will be compensated, how other members of the LLC will be compensated, and any other financial considerations.
• Make sure to include how often payments will be made and who is responsible for initiating the payments.
• Draft the payment and reimbursement terms in the operating agreement.
• Have all members of the LLC review and approve the payment and reimbursement terms.
• Once all members of the LLC have approved the payment and reimbursement terms, check this step off your list and move on to the next step.

Defining the taxation requirements

• Determine the type of business entity (i.e. LLC, LLP, S-Corp etc.)
• Research the federal, state, and local taxes applicable to the business entity
• Specify the tax obligations of the members, such as filing and payment of returns
• Outline the procedures for collecting and distributing taxes
• Include any provisions regarding tax-related responsibilities or liabilities of the members

When you can check this off your list:
Once the taxation requirements of the business have been specified, you can move on to the next step.

Setting out the company’s rules and regulations

• Draft rules and regulations that will govern the company, including the roles and responsibilities of each member, how profits and losses will be allocated, procedures for decision-making, and the processes for resolving any disputes
• Consider how to document changes to the rules and regulations in the future
• Include provisions for the company’s dissolution
• Have the operating agreement reviewed by an attorney
• Once the operating agreement is finalized and signed by all the members, you can check this off your list and move on to the next step.

Outlining the company’s internal policies

• Brainstorm and list out potential policies and procedures that need to be included in the agreement
• Decide which policies are appropriate for the company, and which should be omitted
• Establish guidelines for the roles and responsibilities of each member of the LLC
• Create a framework for how the company will handle decisions, profits, and losses
• Set out rules for how the company will operate on a day-to-day basis
• Outline the procedures for how the LLC will handle conflicts between members
• Include any other policies that are necessary for the LLC
• Once all policies have been outlined and agreed upon, move on to determining the procedure for amending the agreement.

Determining the procedure for amending the agreement

• Decide who will be responsible for proposing amendments to the agreement
• Determine how often the agreement should be reviewed
• Outline the process for approving amendments to the agreement
• Consider whether a majority or unanimous vote is needed for approval of amendments
• Agree on the timeframe for implementing any approved amendments
• Specify any additional steps that should be taken when proposing or approving amendments

When you have outlined the procedure for amending the agreement, you can check this step off your list and move on to specifying the rules for hiring employees.

Specifying the rules for hiring employees

• Decide on the process for recruiting, interviewing, and hiring employees.
• Create a job description for each position that clearly outlines the responsibilities and expectations.
• Make sure you are aware of any applicable legal requirements, such as background checks or drug testing.
• Determine the wages, benefits, and vacation policies.
• Outline the conditions under which an employee can be terminated, such as cause or failure to meet performance standards.
• Include any additional policies, such as dress code or attendance.

Once you have determined the rules for hiring employees and included them in the operating agreement, you can check this off your list and move on to the next step of the guide.

Providing for dispute resolution

• Determine the process for resolving disputes between members of the LLC:
• Lay out the steps that will be taken in the process, such as coming to an agreement through negotiation, mediation, or arbitration
• Set forth any rules that will govern the dispute resolution process, such as a specific timeline or the rules of evidence
• Outline the decision-making process for resolving disputes:
• Specify whether all members must agree or if a majority vote is sufficient
• Determine how to break a tie in the case of an even number of members
• Add a clause to the operating agreement that outlines the dispute resolution process

You’ll know you can check this off your list when you have added a clause to the operating agreement outlining the dispute resolution process.

Establishing a dispute resolution procedure

• Establish a formal dispute resolution process in the operating agreement. This should include steps to be taken to resolve a dispute, such as negotiation, mediation, and arbitration.
• Make sure the procedure is clear and concise, and that all parties understand their responsibilities in the event of a dispute.
• Include a clause in the agreement that any dispute must be resolved in a timely manner and all parties must agree to abide by the decision of the dispute resolution process.
• When you are finished creating the dispute resolution procedure, make sure all parties have read and agreed to it. Once this step is complete, you can move on to the next step of designating a dispute resolution facilitator.

Designating a dispute resolution facilitator

• Choose a dispute resolution facilitator that is knowledgeable about the applicable laws in your state
• Make sure the facilitator is familiar with the parties involved and can remain impartial
• Discuss and agree on the fees associated with the dispute resolution facilitator
• Document the name, contact information and role of the dispute resolution facilitator
• Once all the parties involved have agreed on the dispute resolution facilitator, you can check this step off your list and move on to the next step.

Specifying the terms of arbitration if needed

• Decide on the type of arbitration you need if any (for example, binding arbitration or non-binding arbitration)
• Determine the specific process of arbitration and how it will be administered (for example, who will be the arbitrator, how many arbitrators are necessary, and how will the decision be made)
• Outline the criteria used to select the arbitrator
• Specify the type of dispute that can be subject to arbitration
• Agree on the arbitration rules you will use (for example, the American Arbitration Association, the International Chamber of Commerce, etc)
• Include details on the cost of arbitration, the hearing location, and the language of the arbitration
• When complete, you will have specified the terms of arbitration in the operating agreement.

Establishing the terms of dissolution, if needed

• Decide the conditions for dissolving the business and document them in the Operating Agreement
• Determine the responsibilities of the members in the event of dissolution, such as the distribution of assets, liabilities and profits
• Specify any restrictions or conditions that must be met in order to dissolve the business
• Ensure the Operating Agreement is signed and dated by all members
• Once the Operating Agreement is signed and dated, you can move on to the next step in creating your Operating Agreement.

Outlining the process for winding up the business

• Decide the order of winding up the business, such as paying off any debts, distributing assets to the members, and filing any necessary paperwork
• Draft a provision in the Operating Agreement outlining the winding up procedure, including any necessary decision making requirements
• Make sure that all members agree to the provision and sign off on it
• Once all members have signed off on the provision, the Operating Agreement is complete and ready to be used
• You can now check this step off your list and move on to the next step - specifying the assets to be distributed.

Specifying the assets to be distributed

• Determine the assets of the business, such as real estate, inventory, intellectual property, and cash.
• Divide the assets owned by the business between the members in a way that is fair.
• List the assets, their value, and the portion of each asset each member will receive.
• Outline any restrictions that may apply to the assets, such as agreements or limitations regarding the transfer of assets.
• Make sure to include language that specifies how the assets will be divided in case of dissolution of the business.
• When you have finished specifying the assets to be distributed, ensure that all parties have agreed to the terms and have signed the document.

Establishing any liquidation procedure

• Set out a process for dissolving the LLC and distributing the assets among the members
• Include details such as how assets will be valued, how they will be distributed and who will be responsible for handling the liquidation process
• Decide whether you would like to have a third-party mediator to handle the liquidation process
• Make sure to include a process in the event that members disagree on the liquidation procedure
• Once you have established the liquidation procedure and all members agree, you can check this step off your list and move on to the next step.

Listing the necessary signatures and dates of execution

• Determine the number of members necessary to execute the agreement.
• Collect all signatures necessary for the agreement.
• Collect the date of execution for each signature.
• Ensure all necessary signatures and dates of execution have been collected.
• Record all of the signatures and dates of execution in the Operating Agreement.
• Check that all the signatures and dates of execution are accurate.

You will know this step is complete when all necessary signatures and associated dates of execution have been collected, recorded, and checked for accuracy.

Specifying who must sign the agreement

• Identify all the members of the LLC who must sign the agreement.
• Ensure that the members are all over the age of 18 and are legally allowed to sign the agreement.
• Contact each member and ask them to sign the agreement.
• Keep track of the signatures and dates of execution for each member.

When you have a signature and date of execution from each member, you can check this step off your list and move on to the next step.

Establishing the date of execution

• Determine the date of execution: Make sure to include the date of execution on the operating agreement document.
• Specify the exact date: Make sure to include the exact date when the agreement will be considered finalized and in effect.
• Have all parties sign the agreement: All parties must sign the operating agreement on the date of execution in order for it to be considered valid and binding.
• Check off the step: Once all parties have signed the agreement, you can check off this step and move on to the next.

Establishing the applicable laws and regulations

• Identify the state of incorporation - Each state has different laws and regulations that will apply to the LLC; this should be taken into consideration when establishing the applicable laws and regulations.
• Research any applicable federal regulations - Depending on the nature of the LLC, certain federal regulations may apply, such as securities and tax laws.
• Research the applicable state laws and regulations - The LLC must comply with all applicable state laws and regulations, including those related to taxation, employment, and professional licensing.
• Include any applicable laws and regulations in the operating agreement - All applicable laws and regulations must be outlined in the operating agreement so that all members are aware of their obligations.

How you’ll know when you can check this off your list and move on to the next step: Once you have identified the applicable state and federal laws and regulations and included them in the operating agreement, you will be able to move on to the next step of setting out the process for filing the agreement.

Setting out the process for filing the agreement

• Research the laws and regulations applicable to forming an Operating Agreement in your state
• Research the laws and regulations applicable to forming a Limited Liability Company in your state
• Draft the Operating Agreement and make sure it covers all the relevant topics like membership, management, voting procedures, etc.
• Have each party sign the Operating Agreement
• File the Operating Agreement with the Secretary of State or other applicable government agency
• Obtain an official copy of the Operating Agreement for each party
• Once the Agreement has been properly filed, you can check this off your list and move on to the next step.

FAQ

Q: What is the difference between creating an Operating Agreement and a Shareholder Agreement?

Asked by Abigail on March 11, 2022.
A: An Operating Agreement is a legal document that outlines the rules and regulations of a limited liability company (LLC), while a Shareholder Agreement outlines the rights, responsibilities and obligations of shareholders in a company.

The Operating Agreement defines how the LLC will be managed, which can include who manages the LLC, how decisions are made and how profits and losses are distributed. It also includes information about how members can join or leave the LLC, how members can transfer interest in the LLC, and what happens if the LLC dissolves.

The Shareholder Agreement defines the rights, responsibilities, and obligations of shareholders in a company. It outlines the rights of shareholders in terms of voting, dividends, and other financial benefits associated with being a shareholder. It also outlines any restrictions on the transfer of shares, as well as any restrictions on dividends that may be paid out to shareholders.

Q: How important is it to have an Operating Agreement in place?

Asked by Zachary on December 4, 2022.
A: An Operating Agreement is an important tool for managing and operating an LLC. It provides clarity for all members of the LLC with regard to their roles and responsibilities as well as outlining procedures for decision making and dispute resolution. Having an Operating Agreement in place ensures that all members are aware of their rights and obligations as part of the LLC, which helps to prevent disputes from occurring. Additionally, having an Operating Agreement in place can help protect the LLC from personal liability for debts or obligations incurred by its members.

Q: Is it necessary to have a lawyer create my Operating Agreement?

Asked by Madison on February 22, 2022.
A: Although it is not necessary to hire a lawyer to create your Operating Agreement, it is highly advisable since it is important to ensure that your document meets all legal requirements in your jurisdiction. A lawyer will also be able to help you tailor your Operating Agreement to fit your specific business needs and comply with all applicable laws. Additionally, if you do hire a lawyer they will be able to provide you with advice regarding potential tax liabilities associated with operating an LLC or other potential legal issues that may arise down the line.

Q: What should I include in my Operating Agreement?

Asked by Joseph on April 5, 2022.
A: Your Operating Agreement should include information about each member of the LLC such as their name and address; information about how profits and losses will be distributed; information about how decisions will be made; information about how members can join or leave the LLC; information about how members can transfer interest in the LLC; information about what happens if the LLC dissolves; and any other rules or procedures that you wish to include. Additionally, depending on your jurisdiction there may be certain clauses or provisions that must be included in order for your document to be legally binding such as limitations on liability for debts or obligations incurred by members of the LLC.

Q: How does UK law differ from US law when creating an Operating Agreement?

Asked by Noah on July 1, 2022.
A: In general, UK law is more restrictive than US law when it comes to creating an Operating Agreement. For example, UK law requires that certain clauses or provisions must be included in order for an agreement to be legally binding while US law does not have this requirement. Additionally, UK law requires that certain aspects of operations such as voting rights must be outlined while US law does not have this requirement unless specified by state law. Finally, UK law also has more stringent reporting requirements when it comes to filing taxes while US laws vary depending on state laws and regulations.

Q: How does EU law differ from US law when creating an Operating Agreement?

Asked by Emma on May 15, 2022.
A: EU law is generally more restrictive than US law when it comes to creating an Operating Agreement due to EU regulations such as GDPR (General Data Protection Regulation) which require additional protections for data privacy than those provided by US laws such as HIPAA (Health Insurance Portability and Accountability Act). Additionally, EU law requires certain clauses or provisions must be included in order for an agreement to be legally binding while US law does not have this requirement unless specified by state law. Finally, EU laws have stricter reporting requirements when it comes to filing taxes while US laws vary depending on state laws and regulations.

Q: Are there any specific considerations I should take into account when creating an Operating Agreement for my SaaS business?

Asked by Olivia on August 24th 2022.
A: When creating an operating agreement for a SaaS business there are a few important considerations you should take into account such as outlining expectations regarding customer service and support; clarifying roles and responsibilities among team members; outlining procedures for decision making; addressing intellectual property ownership; specifying acceptable use policies; outlining payment terms; setting out service levels agreements; establishing data security protocols; defining customer data privacy policies; clarifying confidentiality agreements; establishing dispute resolution procedures; providing termination clauses; specifying tax reporting requirements; determining profit sharing arrangements; establishing exit strategies; specifying arbitration clauses; and outlining non-compete agreements if applicable.

Q: What should I consider when creating an Operating Agreement for my Technology business?

Asked by Emily on October 20th 2022.
A: When creating an operating agreement for a Technology business there are several considerations you should take into account such as outlining expectations regarding customer service and support; clarifying roles and responsibilities among team members; outlining procedures for decision making; addressing intellectual property ownership; specifying acceptable use policies; outlining payment terms; setting out service levels agreements; establishing data security protocols; defining customer data privacy policies; clarifying confidentiality agreements; establishing dispute resolution procedures; providing termination clauses; specifying tax reporting requirements; determining profit sharing arrangements; establishing exit strategies; specifying arbitration clauses; providing warranties for software products or services offered through your Technology business if applicable ; determining whether subcontractors need owning agreements with your Technology business if applicable ; outlining non-compete agreements if applicable ;and outlining indemnification clauses if applicable .

Example dispute

Suing for Breach of Operating Agreement

• A plaintiff may raise a lawsuit for breach of operating agreement if they believe that the other party has violated the terms of the agreement.
• The plaintiff must prove that the other party failed to comply with the terms of the agreement, and that this failure resulted in damages to the plaintiff.
• The plaintiff must provide evidence that the other party knew or should have known that their actions were in breach of the agreement.
• The plaintiff must provide evidence that they suffered damages as a result of the breach, such as financial losses or other harms.
• The defendant may be ordered to pay damages to the plaintiff to cover the costs of the breach.
• The court may also order the defendant to comply with the terms of the agreement going forward.
• If the court finds that the breach was intentional, the plaintiff may be able to recover punitive damages as well.

Templates available (free to use)

Contract Operating Agreement
Ebt Operating Agreement
Joint Operating Agreement
Model Form Operating Agreement
Series Llc Operating Agreement

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