Operating Agreement

An Operating Agreement is a foundational legal document used by limited liability companies (LLCs) in the United States to define ownership, management structure, financial rights, and operational rules. While not always required to be filed with a state agency, an operating agreement plays a critical role in establishing internal governance and preserving limited liability protections.

Operating agreements are governed primarily by state LLC statutes, not federal law. As a result, their legal effect, enforceability, and default rules vary depending on the state in which the LLC is formed.

What Is an Operating Agreement?

An operating agreement is a private contract among LLC members that outlines how the company will be owned, managed, and operated. It supplements state LLC laws by allowing members to customize rules that would otherwise be imposed by statutory default provisions.

Unlike Articles of Organization, which are filed with a state, operating agreements are internal documents and are generally not submitted to a Secretary of State.

Is an Operating Agreement Required?

Operating agreement requirements vary by state:

• Some states explicitly require LLCs to adopt an operating agreement (e.g., California, New York, Delaware).
• Other states do not mandate an operating agreement but strongly recognize and enforce them.
• In states where not required, LLCs without an operating agreement are governed entirely by default state LLC statutes, which may not reflect the members’ intentions.

Most state requirements and default rules are set forth in each state’s Limited Liability Company Act, typically published on official government websites, such as:

• California
• Delaware
• Virginia

Why an Operating Agreement Is Important

An operating agreement serves several essential purposes:

• Clarifies ownership percentages and capital contributions
• Defines management authority and decision-making processes
• Establishes profit and loss allocation rules
• Reduces disputes among members
• Strengthens liability protection by demonstrating separation between owners and the business
• Provides banks, lenders, and the IRS with proof of authority and structure

The Internal Revenue Service (IRS) frequently relies on operating agreements to determine tax classification and ownership authority when issuing EINs or reviewing filings:
https://www.irs.gov/businesses/small-businesses-self-employed

Single-Member vs. Multi-Member Operating Agreements

Single-Member LLC Operating Agreement

A single-member operating agreement documents:

• Sole ownership
• Management authority
• Succession planning
• Tax classification (default or elected)

Although there is only one owner, having a written agreement helps demonstrate that the LLC is a separate legal entity, which is important for liability protection and banking.

Multi-Member LLC Operating Agreement

A multi-member operating agreement is more complex and typically addresses:

• Ownership percentages
• Voting rights
• Capital contributions
• Distributions
• Member admission and withdrawal
• Dispute resolution mechanisms

Key Provisions Commonly Included in an Operating Agreement

Ownership and Capital Contributions

This section identifies each member’s ownership interest and outlines:

• Initial contributions (cash, property, or services)
• Whether additional contributions are required
• Consequences for failing to contribute capital

Management Structure

Operating agreements specify whether the LLC is:

• Member-managed, where owners run daily operations
• Manager-managed, where authority is delegated to one or more managers

State statutes generally recognize both structures, but the operating agreement must clearly state which applies.

Voting and Decision-Making

This section defines:

• Voting thresholds (majority, supermajority, unanimous)
• Matters requiring member approval
• Authority limits for managers or members

Absent an operating agreement, many states default to one-member-one-vote, regardless of ownership percentage.

Profits, Losses, and Distributions

Operating agreements explain how profits and losses are allocated and when distributions occur. These provisions are particularly important for federal and state tax reporting and must align with IRS partnership rules when applicable:
https://www.irs.gov/forms-pubs/about-form-1065

Transfer of Membership Interests

Most operating agreements restrict the transfer of ownership interests and outline:

• Buy-sell provisions
• Right of first refusal
• Events triggering mandatory buyouts (death, disability, bankruptcy)

Dissolution and Winding Up

This section establishes the events that cause dissolution and the procedure for winding up the LLC, including asset distribution and filing Articles of Dissolution with the state.

Operating Agreement and State Law

Operating agreements are enforced under state contract law and LLC statutes. While members have broad flexibility, operating agreements cannot override mandatory provisions of state law, such as:

• Fiduciary duties (in some states)
• Statutory filing requirements
• Tax obligations

Most state LLC laws specify which provisions may be modified by an operating agreement and which may not.

Do You File an Operating Agreement With the State?

No. In most states:

• Operating agreements are not filed with the Secretary of State
• They are retained internally by the LLC

Copies may be requested by:

• Banks
• Investors
• Licensing agencies
• Courts
• The IRS

Can an Operating Agreement Be Amended?

Yes. Operating agreements can usually be amended according to the procedure outlined within the agreement itself. Amendments often require:

• Member approval
• Written documentation
• Updated records retained with company documents

Some states require updated information to be reported through annual or periodic reports if management or ownership changes (e.g., Statements of Information or Annual Reports filed with the Secretary of State).

Operating Agreement vs. Articles of Organization

Operating Agreement

• Type: Internal company document
• Purpose: Governs ownership, management, and operations
• Filing requirement: Not filed with the state
• Flexibility: Customizable by members

Articles of Organization

• Type: Public formation filing
• Purpose: Establishes the LLC as a legal entity
• Filing requirement: Filed with the Secretary of State
• Flexibility: Limited to statutory requirements

Both documents work together but serve different legal purposes.

What Happens If an LLC Has No Operating Agreement?

If an LLC does not adopt an operating agreement:

• State default rules automatically apply
• Members lose control over key governance terms
• Courts may rely solely on statutes to resolve disputes
• Banks and investors may refuse to work with the LLC

When Should an Operating Agreement Be Created?

An operating agreement should ideally be created:

• Immediately after forming the LLC
• Before opening a business bank account
• Before admitting new members
• Before seeking financing or licenses