An Entrepreneur’s Checklist for Drafting an LLC Operating Agreement

Before your business opens its doors to its target consumers, ask yourself this: did you set the stage correctly for long-term success? For many startups, this means forming a business entity, especially an LLC or limited liability company. And along with it, create an operating agreement that specifies the structure, decision-making process, and management of a startup. Think of this contract as a playbook for how to operate and manage your venture. With it, you’ll prevent internal disputes, financial problems, and poor management, which are major reasons nearly 50% of small businesses fail within the first five years, according to the US Chamber of Commerce. That said, learning how to draft operating agreements lowers chances of misunderstandings with partners and legal issues in the future. Ready to navigate the path to business success with a well-thought agreement for your firm’s operations? Here’s a checklist for creating your business’s operating contract without mistakes.

Customize Templates

Nothing seems wrong with using one-size-fits-all templates for documenting how your business operates. But a generic template hinders you from addressing specific needs. It can get you into legal problems like deadlocks or the inability to transfer contribution shares when you rely on one-size-fits-all templates. A customizable document layout lets you tailor governance policies. For example, you can create unique rules for how members exit and join the company to prevent conflicts while fostering business continuity. 

Basic Business Info 

What should be on the first page of operating contracts? Begin with the business name and primary location. Include the date of LLC formation, the state of registration, business activities, and the name of the registered agent. Wondering why it’s crucial to include the registered agent’s name? These professionals handle all official tax and legal issues. And it’s important that all business partners know who they can contact if they need copies of legal files or annual reports.

While hiring these service providers comes with an extra cost, some offer affordable rates that make business formation and management affordable. For example, if you use this Northwest Registered Agent discount, the service fee drops from $100 to $39 plus state fees. And you get a full year of free services for proper documentation and legal updates. Plus, working with a registered agent means you’re complying with state requisites for running an LLC, which gives you peace of mind. 

State Ownership and Voting Rights

Your startup’s operating contract should clarify the percentage a member owns in the company. So, outline each member’s initial contribution, which may be cash, property, or services. Then specify if members are required to make additional contributions in the future. Next, determine voting rights, how resolutions will be passed, and the voting process. Typically, voting powers are equivalent to ownership percentages. But voting rights can be modified to align with your business setting and goals. For example, you could give one individual the authority to decide about daily operations. But for big decisions like signing contracts with other businesses or vendors, all members should decide using an equally weighted vote. 

Management Structure and Exit Strategy

Default state laws for LLCs will consider your business as member-managed if it lacks internal operating laws. What does this imply? All members take responsibility for managing the business. But what if you and some members don’t want to handle daily operations? In your operating agreement, you can define your business as manager-managed. A manager, who may or may not be a partner, can be appointed to manage the company while members focus on other important business issues. 

This section should also describe the responsibilities of partners and managers to prevent disputes or miscommunication on who handles certain duties and who doesn’t. Don’t forget to highlight how members exit the partnership and transfer their rights or shares. The agreement can ban an individual from selling their ownership stakes to a third party without a unanimous vote or consent from other members, for example. Or it could specify that the first offer of transferring interests be given to members before considering outsiders.

Profit and Loss Sharing 

The default setting for profits is that every member receives an equal portion of the gains, regardless of their personal contributions. With an operating agreement, you can customize profit-sharing strategies for your LLC. For instance, members can agree that a partner who contributed 80% of the capital receives a larger portion of the profits. A special profit allocation can also be included to allow specific profit percentages or amounts to be given to members under certain circumstances. For example, a member managing the daily operations of the venture can receive a predetermined percentage off the top before the distribution of profits. Distribution of losses should also follow agreed terms. 

It’s easy to look at an operating agreement as a simple piece of paperwork. But it’s a critical safeguard for your business. When you define ownership, management, exit, and profit-and-loss distribution, you protect all involved parties and create stability for the business. So,make sure you have this document prepared before paying attention to marketing or scaling.