By Jake Lawson, LLC Formation Strategist
Here’s a conversation I have at least twice a week: “Jake, I formed my LLC six months ago. Do I really need an Operating Agreement?”
My response is always the same: “Do you need a foundation for your house?”
Look, I’ve seen over 1,200 LLCs launch successfully, and I’ve also seen dozens crash and burn. Want to know the difference? The successful ones treat their Operating Agreement like their business bible—the document that prevents partnerships from imploding, protects assets from lawsuits, and keeps the IRS happy.
The failed ones? They skip the Operating Agreement because “it’s just paperwork” and then wonder why their business partner cleaned out the bank account or why a judge pierced their corporate veil.
Don’t be the latter group. Let me show you exactly what an Operating Agreement is, why you absolutely need one (even as a single-member LLC), and how to get it right the first time.
What Is an LLC Operating Agreement? (Your Business Constitution)
Think of your Operating Agreement as your LLC’s constitution—the supreme law that governs how your business operates. It’s a written contract between all LLC members that spells out:
- Who owns what percentage of the company
- How decisions get made (and who makes them)
- How profits and losses are distributed
- What happens when someone wants out (or dies)
- How the business gets managed day-to-day
- What happens if things go sideways
Here’s what most people don’t realize: your Operating Agreement is an internal document. You don’t file it with the state, you don’t send it to the IRS, and you don’t publish it in the newspaper. It stays in your business files, but it’s arguably the most important document your LLC will ever have.
Why You Need an Operating Agreement (Even If You’re Flying Solo)
I get pushback on this all the time: “Jake, I’m a single-member LLC. Why do I need an Operating Agreement with myself?”
Here’s why you’re playing with fire without one:
1. Asset Protection (Your Main Shield)
Without an Operating Agreement, courts might treat your LLC like a joke. I’ve seen judges pierce the corporate veil and go after personal assets because the business owner couldn’t prove they operated as a legitimate business entity.
Real example from my files: Client didn’t have an Operating Agreement. Got sued. Court said, “If you don’t have basic business documents, you’re not really running a business—you’re just a person with an LLC filing.” Client lost personal assets that should have been protected.
2. Banking and Lending Requirements
Try getting a business loan or opening certain bank accounts without an Operating Agreement. Many institutions require it as proof that you’re running a legitimate business operation.
I’ve had clients drive to the bank thinking they’re opening an account, only to get turned away because they didn’t have this “simple piece of paperwork.”
3. State Default Rules Suck
Here’s something that’ll shock you: if you don’t have an Operating Agreement, your state’s default LLC laws govern your business. And let me tell you, those default rules were written by bureaucrats, not entrepreneurs.
Examples of terrible default rules:
- All members have equal say (even if someone owns 90% and another owns 10%)
- Unanimous consent required for major decisions (one stubborn partner can paralyze the business)
- Profits distributed based on ownership percentages (no flexibility for sweat equity or different contribution types)
4. Tax Election Protection
Your Operating Agreement helps cement your tax status with the IRS. Single-member LLCs are taxed as sole proprietorships by default, but you might want to elect S-Corp status. Your Operating Agreement provides documentation for these elections.
5. Credibility with Everyone
Investors, partners, vendors, and professional advisors expect legitimate businesses to have Operating Agreements. Not having one immediately signals “amateur hour.”
What Goes Into Your Operating Agreement (The Essential Elements)
After reviewing hundreds of Operating Agreements, here are the sections that actually matter:
1. Basic Company Information
- LLC name and formation date
- Registered agent and office address
- Business purpose (can be broad like “any lawful business activity”)
- Duration (most are perpetual unless dissolved)
2. Membership Structure
This is where things get interesting. You need to define:
- Who the members are (names and addresses)
- Ownership percentages (this can be anything—50/50, 60/40, 90/10, whatever makes sense)
- How membership interests can be transferred (spoiler: you want restrictions here)
- What happens if someone dies or becomes incapacitated
3. Management Structure
LLCs can be managed two ways:
- Member-managed: All owners participate in day-to-day decisions
- Manager-managed: Designated managers run the show (owners may or may not be managers)
My recommendation: Unless you have silent investors, go member-managed. It’s simpler and gives you more control.
4. Financial Provisions
- How profits and losses are distributed (usually by ownership percentage, but doesn’t have to be)
- Capital contribution requirements (what each member puts in)
- How additional capital gets raised if needed
- Banking and financial management procedures
5. Decision-Making Rules
- What requires unanimous consent vs. majority vote
- How meetings are conducted (if at all)
- Voting procedures for major decisions
- Deadlock resolution procedures
6. Exit Strategies
This is where partnerships go to die if you don’t plan ahead:
- Buy-sell provisions (how to handle someone wanting out)
- Valuation methods for departing members’ interests
- Right of first refusal rules
- Death and disability provisions
- Non-compete agreements (if applicable)
Single-Member vs. Multi-Member Operating Agreements
Let me clear up some confusion I see constantly:
Single-Member LLC Operating Agreement
Yes, you still need one. It should include:
- Your role as the sole member and manager
- How you’ll handle business decisions
- Asset protection provisions
- Succession planning (what happens if you die or become incapacitated)
- Tax election documentation
Pro tip: Even if you’re solo now, include provisions for adding members later. Trust me—changing from single-member to multi-member is a pain if your Operating Agreement isn’t set up for it.
Multi-Member LLC Operating Agreement
This is where things get complex fast. You need to address:
- Ownership percentages (and whether they can change)
- Management roles and responsibilities
- Decision-making authority for different types of decisions
- Compensation for members who work in the business
- Dispute resolution procedures (because partners always fight eventually)
- Exit mechanisms (because partnerships don’t last forever)
Common Operating Agreement Mistakes That Cost Big Money
After 15 years of fixing these problems, here are the expensive mistakes I see repeatedly:
Mistake #1: Equal Ownership with Unequal Contributions
The scenario: Two partners form a 50/50 LLC. One contributes $100,000 cash, the other contributes “sweat equity.” No Operating Agreement specifies how this works.
What happens: When the business succeeds, the sweat equity partner gets half the profits despite contributing no money. When it fails, the cash partner loses everything while the other partner loses nothing.
The fix: Clearly define what constitutes capital contributions and how ownership percentages relate to actual contributions.
Mistake #2: No Buy-Sell Provisions
The scenario: Three equal partners, no buy-sell agreement. One partner wants out after two years.
What happens: The departing partner demands one-third of the business value (which might be way more than they contributed). The remaining partners can’t afford to buy them out. Business gets paralyzed or has to be sold.
The fix: Include detailed buy-sell provisions with valuation methods and payment terms.
Mistake #3: Unclear Management Authority
The scenario: Member-managed LLC with unclear decision-making authority. Partners disagree on a major contract.
What happens: One partner signs the contract thinking they have authority. The other partner claims it’s invalid. Customer sues. Nobody knows who had the right to sign.
The fix: Clearly define who can bind the LLC in contracts and what types of decisions require consent from other members.
Mistake #4: No Succession Planning
The scenario: Single-member LLC, owner dies, no Operating Agreement with succession provisions.
What happens: LLC might automatically dissolve. Business assets get tied up in probate. Family can’t continue operations. Everything gets sold for pennies on the dollar.
The fix: Include detailed succession provisions and consider a revocable trust structure.
How to Handle Operating Agreement Changes
Your Operating Agreement isn’t carved in stone. As your business evolves, it should too. Here’s how to handle changes:
Simple Changes (DIY Territory)
- Member address changes
- Registered agent updates
- Minor administrative updates
Process: Amend the original agreement, have all members sign, keep copies of all versions.
Complex Changes (Lawyer Territory)
- Ownership percentage changes
- Adding or removing members
- Changing management structure
- Buy-sell activations
Why you need help: These changes can trigger tax consequences, SEC regulations, or state filing requirements. Mess them up and you could face penalties, additional taxes, or legal liability.
Who Needs to See Your Operating Agreement
Your Operating Agreement is internal, but you’ll need to share it with:
Definitely Will Ask For It
- Banks and lenders (for business accounts and loans)
- Title companies (for real estate transactions)
- CPAs and tax professionals (for proper tax planning)
- Attorneys (for legal advice and contract review)
- Insurance companies (for business insurance policies)
Might Ask For It
- Potential investors or partners
- Major vendors offering credit terms
- Landlords for commercial lease agreements
- Courts (if you’re ever involved in litigation)
Operating Agreement Templates: The Good, Bad, and Ugly
Let’s talk about where to get your Operating Agreement:
The Good: Professional Templates
Quality templates from reputable sources can work for simple situations. Look for templates that include:
- Multiple management structure options
- Customizable ownership provisions
- Standard buy-sell language
- Asset protection features
The Bad: Free Generic Templates
These usually lack state-specific provisions and don’t address complex situations. They’re better than nothing but won’t protect you in sophisticated scenarios.
The Ugly: DIY Disasters
I’ve seen people try to write Operating Agreements from scratch using generic business advice. These often include provisions that contradict each other or create unintended consequences.
My recommendation: Start with a quality template, but have an Attorneys review it if your situation involves:
- Multiple members with different contribution types
- Complex ownership structures
- Plans for raising outside investment
- High-liability business activities
- Significant personal assets to protect
State-Specific Considerations
While Operating Agreements are largely similar across states, some jurisdictions have unique requirements:
States That Require Operating Agreements
- Delaware: Required for LLCs with more than one member
- California: Strongly recommended; default rules are particularly onerous
- New York: Not required but essential for asset protection
States With Unique Provisions
- Nevada: Provides a statutory Operating Agreement form
- Wyoming: Strong asset protection laws that affect Operating Agreement language
- Texas: Specific provisions for professional LLCs
Bottom line: Always check your state’s specific requirements and consider having local counsel review your agreement.
The Tax Angle: How Your Operating Agreement Affects Your Taxes
Your Operating Agreement can significantly impact your tax situation:
Tax Elections
Your Operating Agreement should document any tax elections:
- S-Corp election (Form 2553)
- Partnership election (usually automatic for multi-member LLCs)
- Corporate taxation election (Form 8832)
Profit and Loss Allocation
You can allocate profits and losses differently from ownership percentages, but it must be documented in your Operating Agreement. This is called “special allocation” and it’s powerful for tax planning.
Example: 50/50 ownership, but 70/30 profit split to reflect different levels of involvement.
Capital Account Tracking
Multi-member LLCs need to track each member’s capital account for tax purposes. Your Operating Agreement should specify how this gets done.
Digital Age Considerations
Modern Operating Agreements should address digital assets and remote operations:
Digital Assets
- Cryptocurrency holdings and wallet access
- Domain names and intellectual property
- Social media accounts and digital marketing assets
- Software licenses and digital tools
Remote Operations
- Virtual meeting procedures
- Electronic signature requirements
- Digital document storage and access
- Cybersecurity responsibilities
Your Operating Agreement Action Plan
Here’s your step-by-step approach:
Step 1: Assess Your Situation
- Single or multi-member LLC?
- Simple or complex ownership structure?
- High or low liability business?
- Significant assets to protect?
Step 2: Choose Your Approach
- Simple situation: Quality template with attorney review
- Complex situation: Custom drafting by experienced attorney
- Budget constraints: Template now, attorney review when you grow
Step 3: Gather Required Information
- Member names and addresses
- Ownership percentages
- Capital contributions (cash, property, services)
- Management structure preferences
- Business purpose and activities
Step 4: Draft and Review
- Create initial draft using template or attorneys
- Review with all members (if multi-member)
- Negotiate any changes before finalizing
- Have attorney review if situation warrants
Step 5: Execute and Maintain
- All members sign the final agreement
- Keep copies in multiple secure locations
- Review annually and update as needed
- Update when major changes occur
Red Flags That Require Professional Help
Call an attorney if your situation includes:
Business Structure Red Flags
- Multiple classes of membership interests
- Silent investors or outside funding
- Management companies or complex structures
- International members or operations
Legal Risk Red Flags
- High-liability business activities
- Professional licensing requirements
- Significant personal assets at risk
- Existing legal disputes or potential litigation
Tax Complexity Red Flags
- Multiple tax elections or strategies
- Real estate investments or development
- Complex capital structures or special allocations
- International tax implications
The Bottom Line: Your Operating Agreement Is Your Business Insurance Policy
After helping over 1,200 entrepreneurs launch successful LLCs, here’s what I know for certain: your Operating Agreement is the difference between a business that survives challenges and one that gets destroyed by them.
I’ve seen partnerships implode because nobody thought to address what happens when someone wants out. I’ve watched single-member LLCs lose asset protection because they couldn’t prove they operated as legitimate businesses. I’ve seen families fight over business assets because the Operating Agreement didn’t address succession.
Don’t let these disasters happen to you. Get your Operating Agreement right from the start, keep it updated as your business grows, and treat it as the business bible it’s meant to be.
Ready to Build Your Business on a Solid Foundation?
Your Operating Agreement is just one piece of building a bulletproof business structure. If you’re still in the formation stage, there are critical decisions about state selection, tax optimization, and asset protection that will determine your long-term success.
Need help making the right strategic decisions for your business? I’ve spent years testing every major formation service and studying the tax implications of different business structures. Some choices can save you thousands in taxes annually, while others can cost you dearly if you get them wrong.
Wondering about the bigger picture beyond just formation? Should you elect S-Corp taxation? How do you structure ownership for future growth? What about asset protection strategies that go beyond basic LLC formation? These decisions compound over time—getting them right early pays dividends for years.
Looking for independent, unbiased advice tailored to your situation? I’ve helped entrepreneurs from all 50 states and 40+ countries build successful U.S.-based businesses. Whether you’re a first-time entrepreneur or expanding an existing operation, the right strategy depends on your specific goals, risk tolerance, and growth plans.
Jake Lawson is an LLC Formation Strategist and Tax Advisor with over 15 years of experience helping entrepreneurs establish and grow successful businesses. He’s guided over 1,200 LLCs to successful launch and provides independent, unbiased business formation advice at llciyo.com. Connect with Jake for strategic guidance on all aspects of business formation, structure optimization, and growth planning.