How do I write my operating agreement?
We will discuss the common provisions below, and include sample language for each to help guide you through the process.
1. Name and Purpose of your LLC
You should already know your LLC's name, as it's registered with your organizing state. However, it's vital to explain the purpose of your LLC. Keeping your purpose statement broad allows for more flexibility and makes it easier to explore new ventures without refiling.
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
Here, specify whether your LLC will be member-managed or manager-managed. This section outlines the rights and responsibilities of members, such as capital contributions, voting rights, and management structure. Though it may appear unnecessary for a single-member LLC, this section is important for establishing your business.
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
The registered agent is responsible for receiving and handling crucial documents on your company's behalf. Including this information in your LLC operating agreement is optional since it's already registered in your organizing state.
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. Duration of Your LLC
The "term of an LLC" represents the lifecycle of your Limited Liability Company. It's the duration the LLC intends to exist, as outlined in your formation documents. While many LLCs are formed to operate indefinitely, you can specify a predetermined period or expiration date.
By default, most states consider LLCs to be "perpetual" – existing for as long as you'd like. In Michigan, most LLCs choose a perpetual duration. Here's a sample provision:
The duration of the Company will be perpetual.
5. Capital Contributions
Capital contributions refer to funds, property, or services you invest in your LLC to initiate operations. It's your initial investment for launching your business. For single-member LLCs, capital can come solely from you, meaning you have the flexibility to decide how much money or assets to put into your company.
Properly documenting capital contributions is essential to provide a clear financial structure and assist with tax purposes.
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
Indemnification provisions in your LLC's operating agreement act as a safety net, protecting members from specific costs related to legal challenges arising from their roles in the company. In essence, the LLC covers legal fees or damages if a member faces a lawsuit connected to their duties.
Clearly define circumstances in which the LLC will provide this protection and any exceptions. Generally, indemnification doesn't cover intentional misconduct or extreme negligence. Tailor these terms to suit your business's specific risks and ensure proper protection.
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
Your Michigan LLC can be taxed in one of four ways: as a sole proprietorship, partnership, S corporation, or C corporation. The tax status of your LLC depends on the number of members and the tax status you select with the IRS.
Make sure your LLC's operating agreement includes sections related to tax status. Discuss your chosen tax status, how you can change it, and how to handle tax returns and allocations (when applicable). This equips your LLC to manage finances, including profits, losses, dividends, and taxes effectively. The objective is to simplify tax-related matters for your business.
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 section indicates when your LLC will distribute profits. For single-member LLCs, this isn't as critical. However, for multi-member LLCs, it's crucial to specify when and how the distributions occur and any prerequisites for this.
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. Agreement Amendments
This is the plan for making changes to your LLC terms. For single-member LLCs, it's quite straightforward. However, for multi-member LLCs, you need to carefully set conditions based on voting percentages and requirements to amend the operating 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
LLCs typically aren't obligated to follow corporate formalities. But, in some scenarios, not following these could risk maintaining your corporate veil. Hence, it's useful to include a waiver of all formalities in your operating agreement.
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
This section acts as a guide for dissolving your LLC and determining who will maintain control in case of your absence or death. This is planning for the unexpected, a crucial component of business risk mitigation.
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 for your operating agreement is when it becomes active. It's the day the agreements "kick into gear."
Do I need to file my Agreement?
Definitely not! Unlike your Articles of Organization (or Certificate of Formation depending on your home state), your operating agreement is an internal document. Simply sign it and keep a copy for your records - easy as pie!
What if I need to add another member to my LLC later?
As a small business owner, expansion and bringing others on board is often the dream. If that day arrives and you're ready to introduce another member to your LLC, you'll need to redo the specified paperwork as per the agreement between yourself and the new partner. Most likely, you'll draft a new agreement since a multi-member operating agreement differs significantly from a single-member one. It might seem like a chore, but it's a great problem to have!