How do I write my operating agreement?
We're about to sift through frequently found provisions with sample phraseology for each to support your crafting process.
1. Name and Purpose of your LLC
By this stage, you'd definitely know the name of your LLC, which means whatever name you registered with when you filed your LLC formation documentation with your organizing state. But you also want to ensure that you elucidate the aim of your LLC. Keep the description broad, so as not to limit your scope of taking up future different ventures without having to refile.
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 part of your agreement signifies whether your LLC will be operated by member-management or manager-management. It also traces the rights and responsibilities of the members like capital contributions, voting rights, and the structure for managing the business. Even though it may appear redundant as a solo entrepreneur, it is indispensable for establishing your single member LLC.
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 is the entrusted person who takes care of receiving and looking after crucial documents on behalf of your company. Even though certain LLC operating agreements include this, it isn't a hard-and-fast rule. That's because this information is already mentioned in your formation documents that you submit to 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 "LLC term" is essentially the lifespan of your Limited Liability Company. This is the intended duration of your LLC existence, as stated in the formation documents. Several business owners initiate their LLCs with the perspective of making them operational indefinitely. However, you retain the option to specify a concrete duration or termination date.
Like most states, Texas too considers LLCs "perpetual," signaling their existence until you decide to wind them up. It's common for Texas LLCs to opt for a perpetual term.
The duration of the Company will be perpetual.
5. Capital Contributions
Capital contributions symbolize the funds, property, or services you cater to your LLC to propel its functions. View it as the initial investment you contribute to get your business on its feet. For single-member LLCs, the important point to note is that you as the sole owner are the only source of capital contributions, which means you decide how much monetary input you wish to invest in your business.
It's pivotal to properly record your capital contributions to present a lucid picture of the business's financial structure and for vital tax-based 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
Indemnification provisions in the LLC Operating Agreement function as a financial safety shield protecting the LLC's members from specific costs relating to legal issues propelling from their duties for the company. That means, if any member faces a lawsuit in relation to their duties for the LLC, it will cover any defrayal of legal expenses or damages.
Your agreement should lucidly define when and under which circumstances the LLC will offer this safeguard, as well as any exclusions. Ordinarily, indemnification doesn't cover intentional misconduct or extreme negligence. It's essential to adapt these terms to the distinctive risks associated with your business to guarantee adequate 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 Texas LLC could be taxed via four methods: as a sole proprietorship, partnership, S corporation, or C corporation. The tax mode for your LLC rests on the member count and the tax status your company selects with the IRS.
It's advisable to include tax-related sections in your LLC's operating agreement. These segments should discuss your selected tax status, the steps to alter it, and the approach towards managing tax returns and allocations (when necessary). This assists your LLC to devise a plan for handling the business finances, which cover profits, losses, dividends, and taxes. The prime goal is to offer a definitive roadmap for managing any tax-related issues that may arise in 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
Your clause pertaining to profit and loss distributions plainly indicates when your LLC will distribute the money it has earned. For single-member LLCs, this isn't critical. For multi-member LLCs, it's vital to indicate when the distributions will occur, what criteria need to be met, and how the distribution process will unfold.
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
What's the game plan when you need to alter anything in your LLC? Simple! You just need to stick to the instructions mentioned in your amendment clause of the LLC. If you're a sole business owner, it's comparatively easier. However, for those managing multiple-member LLCs, the important aspects to pay attention to are voting percentages and the prerequisites to modify 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
Typically, LLCs don't necessarily have to adhere to corporate formalities. That's primarily for corporations. But, there could be instances where not observing formalities could lessen the chances of maintaining your corporate veil. Owing to this fact, it's ideal to include a waiver for all formalities in the 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 outlines the contingency plan for times when things don't pan out exactly as expected. It guides you through the process of dissolving your LLC and specifies who will maintain control of the LLC if you're no longer able to continue.
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 marks the day the agreement becomes operative; you can also think of it as the day the agreement "springs into action."
Do I need to file my Agreement?
No, not at all! Unlike your Articles of Organization (or Certificate of Formation, depending on your home state), your operating agreement doesn't need to be filed or registered anywhere. Treat it as an in-house document that you keep safe in your company's records. Just make sure to sign it and keep it in an easy-to-find place!
What if I need to add another member to my LLC later?
It's a dream for many small business owners when their venture grows beyond their own capacity. If you find yourself in such a fantastic position and are poised to onboard another member to your LLC, there will be some paperwork to do in line with the agreement between the new partner and yourself. Most likely, it'd be best to draft a brand-new agreement, given that a multi-member operating agreement has considerable differences from a single-member operating agreement.
In conclusion, a Texas LLC Operating Agreement is considered an essential document to avert future disagreements by laying out the structure, rights, responsibilities, and protocols for your LLC. While it does require time and forethought to create, the benefits it offers your business, in the long run, are more than worth the effort. So, roll up your sleeves and start drafting this backbone-document for your LLC!