Introduction to Member-Managed LLC Operating Agreement Preparation

If you are reading this article, it is assumed that you have either completed the formation of your LLC, or are in the process of doing so, by preparing and filing the Articles of Organization with your state’s LLC filing office. Although this chapter focuses on member-managed LLCs, where all members participate in managing the business, you may be considering a manager-managed LLC structure instead.

LLC Operating Agreement Template

When reviewing this instruction on how to draft an LLC Operating Agreement, you can access an example template by clicking on the specific provision’s title. For instance:

Template: II. Membership Provision

In a manager-managed LLC, management is conducted either by selected members only or by individuals who are not members. For those interested in this structure, detailed guidance is provided in Chapter 6. However, it’s important to review the first two sections of this chapter before moving on. These sections provide essential information on aspects of LLC operation not covered elsewhere and offer insights on customizing your operating agreement to fit specific management arrangements.

Capital Account Provisions

Capital account provisions outline the types and amounts of capital initially contributed by members of a limited liability company (LLC). Typically, these provisions are detailed in operating agreements prepared by lawyers or accountants and include complex definitions and rules.

The special language incorporated in these agreements is crucial when the distribution of profits and losses among LLC members does not align directly with their respective capital contributions. These rules specify how members’ contributions and distributions should be managed under various circumstances, which is essential for maintaining fairness and clarity within the financial structure of the LLC.

Although the special language for handling different profit and loss allocations (referred to as “special allocations”) can be significant, it may not be necessary for all LLCs. This book’s scope, aimed at a general readership, does not include these complex provisions in its sample operating agreements. For those considering special allocations, it is advisable to consult with a tax adviser to ensure the operating agreement accurately reflects these nuances and complies with tax laws.

This article provides a deeper understanding of the implications of varying profit and loss distributions and the importance of aligning them with the LLC’s overall financial and operational goals.

Buy-Sell Provisions

Buy-sell provisions are crucial for determining the procedure when a member wishes to sell their interest in a business. These provisions address several potential issues that might arise during such transactions.

• Right of First Refusal. One common provision is the “right of first refusal,” which requires a member desiring to sell their interest to offer it to existing members before selling to an external party. Questions include whether the existing members are obliged to match an outside offer or have other specific conditions.

• Valuation of Interests. Determining the value of a member’s interest is a central aspect of buy-sell provisions. This may involve deciding whether an external appraiser should assess the value at the time of sale or if the value should be predetermined in the LLC operating agreement using a specific valuation formula, such as book value, a multiple of earnings, or another method.

• Payment Terms for Buyouts. The terms of payment for buyouts also need careful consideration. Options include paying in a lump sum or in installments, depending on the LLC’s liquidity and borrowing capacity. The agreement may also specify whether installment payments should accrue interest.

• Use of Life Insurance. Another aspect to consider is whether the buyout for a deceased owner should be funded through life insurance purchased by the LLC or its members beforehand, providing a predefined method to handle such situations.

• Circumstances Impacting Buyout Terms. The provisions might also vary based on why or when a member exits the LLC. Different terms could apply depending on the duration of membership, the reasons for departure (e.g., resignation, expulsion, debilitating illness, or death), and the implications of each scenario.

• Planning for the Future. Many businesses choose to address these issues as they arise rather than defining them in detail from the start. It may be deemed sufficient to know that an appraiser can determine a fair value at the time of sale. However, basic transfer restrictions are commonly included in operating agreements to manage the admission of new members, requiring approval from a majority of the existing members.

• Detail-Oriented Planning. For businesses that prefer thorough upfront planning, detailed buy-sell or buyout provisions can be crafted as part of the initial operating agreement. Legal advisors or resources like Nolo’s “Business Buyout Agreements: A Step-by-Step Guide for Co-Owners” can provide guidance and templates to establish comprehensive buy-sell provisions tailored to the business’s specific needs.

Customizing Your LLC Operating Agreement

When crafting your own LLC operating agreement, it’s possible and often necessary to modify existing provisions or add new ones to better suit the specific needs of your business. While altering an LLC operating agreement does not require expert legal knowledge, it does demand common sense and sound business judgment.

Checking Legal Compliance

Before making any changes to your operating agreement, it’s crucial to verify that your modifications are in compliance with state laws. This involves consulting your state’s LLC act to ensure there are no conflicts with statutory regulations. Additionally, consulting a legal or tax advisor is recommended, particularly for significant changes such as adjusting voting rights or requirements for amending organizational documents or dissolving the LLC.

Types of Changes and Their Safety

• Internal Matters. Changes to internal housekeeping provisions, such as specifying the logistics of member or manager meetings or defining qualifications for officers or employees, generally do not conflict with state LLC statutes or tax rules. These areas are mostly left to the discretion of the LLC members, making such modifications relatively safe to implement on your own.
• Legal Procedures. If you’re considering changes that affect legal procedures—like altering the number of votes needed to dissolve the LLC or amend the articles of organization—first check your state’s LLC act. A quick online search can reveal whether there are legal limitations or restrictions on these changes, ensuring that your modifications are legally sound.
• Tax Matters. Modifying provisions that impact tax matters, such as those dealing with the sale of assets or the allocation and distribution of profits, can be complex and carry significant tax implications. It is advisable to have these changes reviewed by an LLC tax adviser. This professional can provide guidance on whether your proposed changes are advantageous, disadvantageous, or neutral from a tax perspective.

As you modify your LLC operating agreement, it’s important to balance autonomy in business operations with adherence to legal and tax regulations. For substantial amendments, especially those affecting the structure and financial aspects of the LLC, professional advice is crucial to ensure compliance and optimize the operational effectiveness of your agreement.

Example 1: Adam and Bob’s LLC Formation and Capital Contributions

• Formation and Initial Contributions. Adam and Bob, friends and former business partners, decide to form an LLC. Adam contributes a substantial amount of cash upfront, while Bob, who lacks immediate funds, signs a promissory note agreeing to pay his share over time with interest.
• Special Profit Allocations. Given that Adam provides cash upfront, it is agreed that he should receive an extra share of the profits to compensate for his immediate capital contribution. Conversely, since Bob hasn’t contributed any capital yet, his capital account starts at zero, and his share will only be credited as he makes payments according to the promissory note.
• Tax Advisory and Compliance. They consult their tax adviser to review these arrangements in their operating agreement, especially because such special allocations of profits may lead to complex tax implications. The adviser integrates IRS-specific language concerning special allocations, ensuring that the agreement complies with technical tax regulations regarding disproportionate profit and loss sharing.

Example 2: David and Frank’s Amendment to Membership Vote Requirements

• Reviewing State Rules. David and Frank aim to amend the voting requirements in their LLC’s member-managed operating agreement to facilitate the transfer of LLC interests to outsiders. They start by consulting the basic state rules of their state to understand the legal flexibility their state offers for such changes.
• Legal Validation. To ensure their changes are legally sound, they consult a legal adviser for advice on aligning their amendments with the latest updates to their state’s LLC act. Alternatively, they consider checking the state LLC act online themselves to directly verify any legal restrictions or allowances concerning their proposed amendments.

Preliminary Provisions

Template: Preliminary Provisions

• Section 1: Naming Your LLC

Insert the legal name of your LLC exactly as it appears in your articles of organization. This is crucial for legal consistency across all your official documents.

• Section 2: Dating the Agreement

The date on the agreement should be on or after the day all members sign it. If uncertain about when all signatures will be collected, you can write “the last date of signing shown at the end of this agreement.” This ensures that the agreement reflects the finalization of all members’ consent.

• Section 3: Signing by All Members

Ensure that all members sign the operating agreement upon completion of the form. This formalizes their acceptance of all terms and conditions laid out within the document.

• Section 4: Including the Formation Date

Record the date when your LLC’s articles of organization or certificate of formation was officially filed with your state’s LLC filing office. Typically, this is the date stamped on the first page of your filed documents or shown on the filing receipt sent by the state office.

By following these steps and referring to the sequential special instructions in the sample operating agreement, you can accurately prepare your member-managed LLC operating agreement to meet legal requirements and reflect the agreed-upon structure and governance of your LLC.

• Section 5: Business Name
  

This section of the operating agreement addresses the possibility of your LLC operating under a name different from the one stated in your articles of organization. If you choose to use an alternative business name, often referred to as a fictitious or assumed name, it is necessary to register this name with the state and in each county where this name will be used. Detailed guidance on this process can be found in Chapter 7 of the handbook, which explains the requirements and steps for registering a fictitious name.

• Section 6: Registered Office and Agent Information

In most cases, the articles of organization will specify details about the LLC’s registered office and its agent. For this section of the operating agreement, simply transfer that information from your articles of organization into the provided spaces in the agreement. The registered office must have a physical street address in the state—it cannot be a post office box. The agent designated must meet state requirements, typically including being at least 18 years of age and a resident of the state. Often, one of the founding members of the LLC will serve as the initial agent, using the principal office address of the LLC as the registered office address.

This part of the operating agreement clarifies the procedure for changing your LLC’s registered agent or office location. To make these changes, you must file the appropriate form with your state’s LLC filing office and pay any applicable fee. Importantly, if you update this information, there is no need to amend it in your existing operating agreement.

Membership Provisions

Template: Membership Provisions

This section outlines the rights and responsibilities of the members of your LLC.

• Section 1: Non-liability of Members

Members of this LLC shall not be held personally responsible for any of the LLC’s debts, obligations, liabilities, or any claims brought against it.

• Section 2: Reimbursement for Organizational Costs

Members who incur organizational expenses will be reimbursed by the LLC. Additionally, the LLC may choose to deduct and amortize these organizational and start-up costs as allowed under the Internal Revenue Code, following advice from the LLC’s tax adviser.

• Section 3: Management

The management of this LLC will be carried out collectively by all members.

• Section 4: Members’ Percentage Interests

Each member’s percentage interest in the LLC will be calculated as a ratio. The numerator is the total of the member’s capital account, and the denominator is the sum of all members’ capital accounts. This ratio will be represented as a percentage in this agreement, defining each member’s “percentage interest” in the LLC.

• Section 5: Membership Voting

Except as may be required by the articles of organization, certificate of formation, or other foundational documents; provisions of this operating agreement; or applicable state laws, each member votes in proportion to their percentage interest in the LLC. A “majority of members” is defined as those holding over 50% of the total membership votes. This majority can decide on any business matter unless a different level of approval is stipulated by this agreement or by law.

• Section 6: Compensation

Members will not receive payment for duties performed in their role as members or managers of the LLC. However, members may be compensated for performing other roles within the LLC, such as officers, employees, independent contractors, or in any other capacity.

• Section 7: Members’ Meetings

Regular members’ meetings are not scheduled by the LLC. However, any member can request a meeting by notifying all other members. Notification can be made personally, in writing, or through electronic means like email, phone, or fax, ensuring it reaches all members. The members must then coordinate to agree on a suitable time and place for the meeting.

• Section 8: Notice and Postponement of Meetings

There is no requirement to provide advance notice about the agenda when a member calls a meeting, and any topic can be discussed or acted upon. If not all members can attend a scheduled meeting, it will be rescheduled to accommodate everyone’s availability, unless the members who cannot attend provide written consent to proceed in their absence. If a rescheduled meeting also fails to gather all members, and written consent from non-attending members is lacking, a second rescheduling may occur. The time and date for this subsequent meeting should be announced during the first rescheduled meeting and communicated to any absent members. This second rescheduled meeting can proceed provided that a majority of the membership’s percentage interests is represented. Decisions or approvals from this meeting should be communicated in writing to any members not present. Additionally, written minutes summarizing discussions, proposals, and outcomes should be documented by a designated member or appointee and later added to the LLC’s records book.

• Section 9: Membership Certificates

The LLC is authorized to issue certificates that represent or certify membership interests. Each certificate will display the LLC’s name and the member’s name, confirming their status as a member and entitling them to all rights specified in the articles of organization, certificate of formation, or similar documents; this operating agreement; and applicable laws. Certificates must be consecutively numbered and signed by one or more of the LLC’s officers. They may include additional details as deemed necessary by the members for inclusion on the certificates.

In addition to the information previously mentioned, all membership certificates must include a clear legend either on the front or back that highlights any restrictions on the transfer of membership interests. These restrictions, outlined in the articles of organization, certificate of formation, or similar documents, and this operating agreement, must be summarized or referenced. The certificates should also provide the address from which members can request a copy of these restrictions.

The LLC’s records book will maintain a detailed registry of all issued membership certificates, including the names and addresses of certificate holders, the dates of issuance, and a record of any certificate cancellations or transfers.

Furthermore, each member must agree to refrain from holding an interest in, managing, or working for any other business, enterprise, or venture that competes with the LLC. Members should avoid engagements that could affect the LLC’s goals, mission, profitability, or productivity, or impair their ability to contribute fully to the management of the LLC.

Tax and Financial Provisions

Template: Tax and Financial Provisions

These sections address the tax and financial considerations necessary for organizing and operating your LLC.]

• Section 1: Tax Classification of LLC

The members designate the LLC to be classified for tax purposes as a [“partnership”, “sole proprietorship” if there is only one member, or “corporation”]. This classification is based on the choice of the members, consistent with federal and state laws. Members may alter this tax classification by collectively agreeing to sign or authorize the signature of IRS Form 8832, Entity Classification Election, and ensuring its submission to the IRS and, where relevant, state tax authorities within the specified deadlines.

• Section 2: Tax Year and Accounting Method:

The LLC will operate on a [“calendar year” or specify a fiscal year]. The accounting method employed will be either [“cash” or “accrual”]. Changes to the tax year or accounting method can be made with unanimous member consent, subject to eligibility and regulatory approval, through the submission of the necessary forms to the IRS and state tax authorities.

• Section 3: Tax Matters Partner

Should IRS regulations require, the LLC will appoint a “tax matters partner” from among its members, in line with Internal Revenue Code section 6231(a)(7) and related regulations. This member will act as the primary contact with the IRS, communicating and managing tax-related matters and updating the other members on the status and results of tax proceedings.

• Section 4: Annual Income Tax Returns and Reports

Within 50 days after the end of each fiscal year, the LLC will distribute copies of its federal and state income tax returns from the prior year to each member. Additional documents necessary for members to complete their personal tax filings will be included. If the LLC is treated as a partnership for tax purposes, this will consist of a Schedule K-1 (Form 1065, Partner’s Share of Income, Deductions, Credits) or its equivalent, alongside a financial report including the LLC’s balance sheet and profit and loss statement for that year.

• Section 5: Bank Accounts

The LLC will select appropriate financial institutions for depositing its funds, which may include savings, checking, and investment accounts necessary for the LLC’s operations. Selected members, with unanimous consent, will manage deposits and withdrawals and oversee the investment decisions regarding these accounts. It is essential that LLC funds are kept separate from the personal funds of any members.

• Section 6: Title to Assets

All assets, whether real or personal, shall be owned by the LLC and titled in its name, rather than in the names of individual members or managers.

Capital Provisions

Template: Capital Provisions

This section outlines the regulations concerning capital contributions, allocations, and distributions among LLC members, along with other related financial matters.

• Section 1: Capital Contributions by Members

Each member is required to contribute cash, property, or services as specified next to their names below. Unless noted otherwise, these contributions should be made to the LLC by the final date or period designated for contributions. The agreed fair market values of any property or services, and the corresponding percentage interests in the LLC each member receives in return for their contributions, are also detailed below.

• • Name |  Contribution | Fair Market Value | Percentage Interest in LLC
• Section 2: Additional Contributions by Members

Members may, by unanimous vote, decide to require additional capital contributions, which must be paid by a mutually agreed date.

• Section 3: Failure to Make Contributions

If a member does not meet the contribution deadline, the other members may unanimously decide to extend the deadline, impose late payment penalties, or apply interest on the overdue amount. Alternatively, they may choose to terminate the delinquent member’s membership, with any prior capital contributions refunded by the LLC upon such termination.

• Section 4: No Interest on Capital Contributions

No interest will be paid on any capital contributed to the LLC nor on the balances in members’ capital accounts.

• Section 5: Capital Account Bookkeeping

The LLC will maintain a capital account for each member, reflecting their contributions, their share of profits, and deducting their share of losses and expenses. These accounts will be adjusted according to relevant tax laws and regulations.

• Section 6: Consent to Capital Contribution Withdrawals and Distributions

Members are not permitted to withdraw any part of their capital contributions or to receive distributions, whether in property or cash, without the written consent of all members, except as provided under this agreement.

• Section 7: Allocations of Profits and Losses

All members will be treated equally with respect to the return of capital, distributions, and allocations of income, gains, losses, deductions, credits, and other items. These will be allocated according to each member’s percentage interest in the LLC.

• Section 8: Allocation and Distribution of Cash to Members

Cash generated from the LLC’s business operations or from the sale of LLC assets may be distributed to members according to their respective interests in the LLC, as decided by the members.

• Section 9: Allocation of Noncash Distributions:

If distributions include noncash property, members will determine the property’s value and allocate it according to each member’s percentage interest. If this property is later converted to cash, the proceeds may be distributed as stipulated in this agreement.

• Section 10: Allocation and Distribution of Liquidation Proceeds

In the event of the LLC’s liquidation or the liquidation of any member’s interest, all financial activities will be allocated to the members’ capital accounts. Following any necessary adjustments, final distributions will be made in proportion to the positive balances in each member’s capital account.

Membership Withdrawal and Transfer Provisions

Template: Membership Withdrawal and Transfer Provisions

This section details the protocols for members who wish to exit the LLC and the transfer of membership interests. Our provisions are designed to comply with stringent state regulations that often require a membership vote to admit a transferee (someone acquiring an LLC interest from a current member) as a new member.

• Section 1: Withdrawal of Members

A member may withdraw from the LLC by submitting a written notice to all other members. This notice must be provided a set number of days (to be specified) before the intended withdrawal date.

• Section 2: Restrictions on the Transfer of Membership

A member cannot transfer their membership in the LLC without first obtaining the approval of all non-transferring members to admit the prospective transferee as a member of the LLC. Additionally, a member is prohibited from encumbering any part or all of their membership interest through mortgages, pledges, security interests, liens, or similar means without the unanimous written consent of all other members. However, a member may assign the economic benefits associated with their membership to another person without requiring approval from other members. This type of assignment does not grant the assignee any of the member’s voting or management rights, nor does it confer membership status in the LLC.

Dissolution Provision

Template: Dissolution Provision

This section outlines the conditions under which the LLC may be dissolved, including specific events that could trigger dissolution. In accordance with Section 1(a), a unanimous vote from all remaining members is required to continue the LLC’s operations after a member loses their membership interest. This requirement is designed to comply with the most stringent state regulations regarding such circumstances.

1. Events That Trigger Dissolution of the LLC: The dissolution of the LLC may be initiated by any of the following events, unless otherwise decided by the members:

(a) Member-Related Events: The death, incapacity, bankruptcy, retirement, resignation, or expulsion of a member. However, within a specified number of days (typically up to 90 days as per state default rules), all remaining members may vote to continue the LLC’s existence, thereby preventing dissolution.

(b) Expiration of LLC Term: The end of the LLC’s designated term of existence, if such a term is specified in the articles of organization, certificate of formation, or a similar document, or within this operating agreement.

(c) Unanimous Member Agreement: The unanimous written consent of all members to dissolve the LLC.

(d) Legal Decree: The entry of a legal decree ordering the dissolution of the LLC under state law.

General Provisions

Template: General Provisions

This section details general guidelines for the operation of the LLC, along with standard clauses typically found towards the end of LLC agreements concerning the enforceability of the agreement.

• Section 1: Officers

The LLC may appoint one or more officers, such as a president, vice president, secretary, and treasurer. It is not required for officers to be members of the LLC. These roles may be compensated or not, depending on the services provided to the LLC. Officers performing only ministerial duties as specified in this agreement will generally not receive compensation, but they can be reimbursed for any out-of-pocket expenses incurred in the performance of their duties.

• Section 2: Records

The LLC will maintain at its principal business address:

• • Records of all membership meetings and financial transactions.
  • A current list of members’ names and addresses, noting any transfers of membership interests or new admissions.
  • Copies of foundational documents like the articles of organization, certificate of formation, and this operating agreement.
  • Tax returns for the previous three years.
  • A statement detailing each member’s capital contributions, scheduled future contributions, members’ rights to distributions of capital, and details about the LLC’s termination as specified in foundational documents or this operating agreement.

If any of the above information is already included in this operating agreement, maintaining a copy of the agreement at the principal business address suffices without the need for separate records.

Members have the right to inspect these records upon reasonable notice to the LLC. While members can copy records, the cost of copying must be borne by the requesting member.

• Section 3: All Necessary Acts

Members and officers of this LLC are empowered to perform all actions necessary to establish and efficiently conduct the LLC’s operations. The Secretary or other appointed officers, as well as all members, may provide certifications to businesses, financial institutions, and individuals confirming the authority of specified members or officers to conduct business on behalf of the LLC.

• Section 4: Mediation and Arbitration of Disputes Among Members

Should any disagreements arise regarding this operating agreement or other member-related disputes that cannot be amicably resolved, the matter will initially be addressed through mediation. The disputing parties will arrange the mediation terms and procedures. If mediation fails or an acceptable resolution cannot be achieved, the dispute may be escalated to arbitration under the rules of the American Arbitration Association. Any party can initiate arbitration by sending a written request to all parties involved in the dispute, outlining the nature of the dispute to be arbitrated. If all parties agree, arbitration will proceed as soon as possible after the receipt of the request.

Costs of arbitration will be shared by all parties initially, but the prevailing party may be awarded attorney fees, costs, and other expenses. Decisions made in arbitration are final, binding, and conclusive for all involved parties, and such decisions can be entered as legal judgments in any court with appropriate jurisdiction.

• Section 5: Entire Agreement

This operating agreement constitutes the full agreement among the LLC members and can only be amended, modified, or superseded by a written document signed by all current members and any new members who have joined the LLC since the original agreement was adopted. This agreement nullifies all prior agreements, whether written or oral, among the members.

• Section 6: Severability

If any part of this agreement is found to be invalid, unenforceable, or ineffective by a court or arbitrator, that specific provision will be severed from the agreement. The validity and enforceability of the remaining provisions will not be affected.

Signatures of Members and Spouses

Template: Signatures of Members and Spouses

This final section of the agreement provides spaces for the signatures of the LLC members and, where applicable, their spouses.

1. Execution of Agreement: In confirmation of their acceptance and adoption of this operating agreement as the governing document of the LLC, the members shall sign below:

Date:
Signature: __________________
Printed Name: _______________, Member

Date:
Signature: __________________
Printed Name: _______________, Member

Date:
Signature: __________________
Printed Name: _______________, Member

2. Consent of Spouses: The undersigned are the spouses of the members of this LLC who have executed the operating agreement as outlined above. These spouses have reviewed the agreement and consent to adhere to its terms regarding any financial interests they hold, including conditions related to the transfer of membership interests and the terms governing the sale or transfer of memberships within this LLC.

Date: _____________________
Signature: __________________
Printed Name: _______________
Spouse of: __________________

Date: _____________________
Signature: __________________
Printed Name: _______________
Spouse of: __________________

Date: _____________________
Signature: __________________
Printed Name: _______________
Spouse of: __________________