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Step-By-Step Guidance for Crafting an Operating Agreement
This guide breaks down standard sections with sample language to make it easier for you.
1. Name and Purpose of your LLC
Your LLC's name is established by the time you register your LLC formation documents with the state. It's also important to describe the purpose of your LLC. A broad statement works well, providing flexibility for potential business expansion without needing to re-register.
OPERATING AGREEMENT of [COMPANY NAME]
This operating agreement is adopted as of [Date] (the “Effective Date”), by [Member’s Name], an individual and the sole member (the “Member”) of [Company Name] (the “Company”).
The Member hereby adopts this agreement as the operating agreement of the Company, which agreement sets forth the entire understanding of the Member regarding its subject matter and supersedes all prior understandings and agreements regarding its subject matter.
The purpose of the Company is [Company Purpose], and the conduct of other activities as may be necessary or appropriate to promote the stated purposes, and to engage in any other lawful business or activity for which a limited liability company may be organized under the Act.
2. LLC Management - Member or Manager
This section determines whether your LLC will be managed by members or a designated manager. It also specifies each member's rights and duties, such as capital contributions, voting rights, and management structure. Even for single-member LLCs, this section is vital to confirm your status.
Member-Managed LLC.
The business and affairs of the Company will be managed by the Member. The vote, action, decision, or consent of the Member will constitute a valid decision of the Member and the Company. The Member may appoint one or more officers (including the Member, if the Member is an individual) who will have such powers and authority to act on behalf of the Company granted to them by the Member.
OR
Manager-Managed LLC.
The business and affairs of the Company will be managed by the manager of the Company and any successor thereto appointed by the Member, which manager may also be referred to as the Company’s president (the “Manager”). The initial Manager will be [Manager Name], who will serve until the Manager’s death, removal by the Member (for any reason or no reason), or resignation. The Manager will have the right and authority to manage the affairs of the Company and make decisions and take action with respect thereto without further approval or consent of any kind by the Member. Except as otherwise required by this agreement and in lieu of any limitations set forth in [State Name]’s laws for limited liability companies (the “Act”), the Manager will be solely responsible for and is hereby authorized to manage and operate the business of the Company. Except to the extent that the authority of the Manager is expressly limited by the Member, the vote, action, decision, or consent of the Manager will constitute a valid decision of the Manager and the Company.
3. Registered Agent
A registered agent handles important paperwork on your LLC's behalf. Though sometimes mentioned in operating agreements, it isn't obligatory as the agent is already identified on your state formation documents.
The Company’s registered agent in State is: Registered Agent Name, Address. The members may designate other registered agents or offices at any time in this state or, if necessary, in other states.
4. LLC Duration
This determines the expected lifespan of your LLC, as indicated in your formation documents. Many entrepreneurs opt to have their LLC operate indefinitely, but you can also specify a particular term or dissolution date.
The duration of the Company will be perpetual.
5. Capital Contributions
Capital contributions involve the initial investment to launch your LLC, such as cash, property, or services. In single-member LLCs, the owner makes the contribution, allowing flexibility in the decision.
Maintaining accurate records of these contributions is crucial, as it ensures a clear financial picture of your LLC and essential tax-related information.
The Member’s capital contribution(s) to the capital of the Company for the Member’s membership interest in the Company will be reflected on the books and records of the Company.
OR
The members have made or shall make the contributions of cash, property or services to the LLC as set forth on Exhibit A attached
6. Indemnification
The indemnification clause offers protection for LLC members from certain legal expenses that could result from their duties within the company. In other words, if a member faces a lawsuit relating to their responsibilities in the LLC, the company may cover legal costs or damages.
Your operating agreement should outline the specific conditions and circumstances under which the LLC provides protection. Note that indemnification typically doesn't cover intentional misconduct or gross negligence.
The Member, the Manager, the officers, and the organizer of the Company and their respective affiliates, stockholders, members, managers, directors, officers, partners, employees, agents, trustees, and representatives (individually, an “Indemnitee”) will be indemnified by the Company against any and all losses, claims, damages, liabilities, expenses (including legal fees and expenses), judgments, fines, settlements, and other amounts arising from any and all claims, demands, actions, suits, or proceedings, civil, criminal, administrative, or investigative, in which the Indemnitee may be involved, or threatened to be involved, as a party or otherwise by reason of the Indemnitee’s status as any of the foregoing, which relates to or arises out of the Company or its assets, business, or affairs, if in each of the foregoing cases (A) the Indemnitee acted in good faith and in a manner the Indemnitee believed to be in, or not opposed to, the best interests of the Company, and, with respect to any criminal proceeding, had no reasonable cause to believe the Indemnitee’s conduct was unlawful, and (B) the Indemnitee’s conduct did not constitute gross negligence or willful or wanton misconduct. The termination of any action, suit, or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere, or its equivalent, will not, of itself, create a presumption that the Indemnitee acted in a manner contrary to that specified in clause (A) or (B) above. Any indemnification under this section 5 will be made only out of the assets of the Company, and the Member will not have any personal liability on account thereof.
7. LLC Tax Status
When it comes to taxes, your Colorado LLC can choose from three main tax designations: a sole proprietorship, partnership, or corporation. Factors like your member count and your election status with the IRS can affect your LLC's tax standing.
A handy tip is to include a clause regarding tax status in your operating agreement. Why? This clause can outline your chosen tax status and describe how to change it, dealing with tax returns, and any allocations (if applicable). This provides a path to handle any tax-related matters and secure your LLC's financial operations, covering areas like profits, losses, distributions, and taxes.
The Company will be disregarded for federal and state income tax purposes. The admission of one or more additional members, however, will cause the Company to be recognized for tax purposes, and to be taxed, as a partnership.
OR
The Member acknowledges that the Company has elected to be taxed as a corporation for federal tax purposes pursuant to the regulations currently in effect under Section 7701 of the Code, and to be taxed as an electing small business corporation under the provisions of Subchapter S of the Code. Notwithstanding such tax treatment, the Member acknowledges and agrees that the Company will be a limited liability company, for state law purposes, under the provisions of the Act, the Articles of Organization, and this operating agreement.
The Member acknowledges that the Company has filed or will timely file a Form 2553 (Election by a Small Business Corporation) with the Internal Revenue Service and that the election made pursuant to the filing is or will be in force and effect covering all periods since the date of this operating agreement. Except as otherwise provided in this operating agreement, during the term of this operating agreement and the continuation of the Company’s “S” corporation election under Section 1362 of the Internal Revenue Code, no Member shall take any action which would cause the revocation or termination of the Company’s “S” election (under Section 1362(a) of the Internal Revenue Code) and any attempt to take such an action will be null and void and without effect. Without limiting the foregoing, and notwithstanding any provision hereof to the contrary, any transfer or attempt to transfer any membership interest to any of the following will be null, void, and without effect:
(a) a person whose ownership thereof would cause the Company to have a number of Members and assignees of membership interests (shareholders of an “S” corporation) greater than the number permitted by Section 1361(b)(1)(A) of the Internal Revenue Code;
(b) an individual who is not a United States citizen or resident;
(c) a trust (or the trustee thereof) which fails to satisfy the requirements of Section 1361(c)(2)(A) or 1361(d) of the Internal Revenue Code;
(d) a corporation; and
(e)any other entity whose ownership would cause the termination or revocation of the Company’s tax status as an “S” corporation.
8. Profit and Loss Distributions
This part of the operating agreement details how profits and losses will be distributed. The process is relatively straightforward for single-member LLCs but requires a detailed approach for multi-member LLCs to avoid confusion.
As the sole member of the LLC, the Member is entitled to all profits of the LLC and is responsible for all its losses. Profits and losses shall be determined annually and will be allocated to the Member's capital account. Distributions of cash or other assets will be made at such times and in such amounts as deemed appropriate by the Member.
9. Amendments to The Agreement
Change is a natural part of any business journey. To modify any terms within your LLC, you'll follow the amendment procedures in the operating agreement. While simple for single-member LLCs, multi-member LLCs must consider voting percentages and requirements for amending the agreement.
This agreement and the articles of organization of the Company may not be altered, modified, or changed, and no provision of this agreement may be waived, except by an amendment or waiver, as applicable, approved by the Member.
10. Corporate Formalities Waiver
Normally, LLCs don’t need to stick to corporate formalities (those formalities are more a corporation’s thing). However, disregarding such formalities could pose a risk to your corporate veil. Therefore, including a waiver of all formalities in your agreement could be beneficial.
The failure of the Company or the Member to observe any formalities or requirements relating to the exercise of its powers or management of its business or affairs under this operating agreement or the laws in the state in which the Company is which govern limited liability companies will not be grounds for imposing personal liability on the Member for liabilities of the Company.
11. Dissolution
The dissolution clause is essentially your LLC's exit strategy, providing guidelines for properly closing down the business and determining who retains control if unforeseen circumstances arise.
Upon the occurrence of any event which terminates the continued membership of the Member in the Company, the Company will not be dissolved, and the business of the Company will continue. The Member hereby specifically consents to such continuation of the business of the Company upon any such event. The Member’s legal representative, assignee, or successor will automatically become an assignee of the Member’s interest and will automatically become a substitute Member in place of the withdrawn Member.
12. Effective Date
The effective date refers to when your operating agreement officially comes into force, marking the beginning of your agreement's life.
Do you need to formally file your Agreement?
No need! Unlike your Articles of Organization, your operating agreement doesn't need to be filed. It’s an internal document. Just sign it, keep a copy for your records, and have it handy when needed.
What If You Need to Add Another Member to Your LLC Later?
Growth can come in various forms, including expanding your LLC team. If you need to add another member later, you'll rework the paperwork according to the terms agreed with the new member. You'll likely need a new agreement since multi-member LLC agreements tend to diverge significantly from single-member LLC agreements.