Operating Agreement
The internal document most LLCs skip, and the one that matters most when a partnership goes sideways.
An operating agreement is the internal governing document of an LLC. It’s the equivalent of corporate bylaws: the rulebook that says who owns what, who makes decisions, how profits flow, and what happens when things change. You don’t file it with any government agency. You keep it internally, and you use it when things get complicated.
Most states don’t require one. Most founders don’t have one. That combination is how you end up in court.
Why Single-Member LLCs Still Need One
If you’re the only owner, you might think this document is irrelevant. It isn’t.
Without an operating agreement, courts in some states may treat your LLC as a sole proprietorship rather than a separate legal entity. That means the liability protection you paid to form could be meaningless. Banks often require an operating agreement to open a business account. And if you ever bring in a co-founder, investor, or partner, starting with one already in place makes that conversation significantly cleaner than drafting one mid-negotiation.
An operating agreement for a single-member LLC is mostly a formality, but it’s a formality that preserves your legal standing.
What a Good Operating Agreement Covers
Ownership and Capital Contributions
This section establishes who owns what percentage of the company and what each member put in to earn it. Capital contributions don’t have to be cash: they can be intellectual property, equipment, time, or existing client relationships. Whatever they are, they need to be documented here, because everything else in the agreement flows from them.
A 50/50 split sounds simple. It isn’t, once you factor in that one founder may contribute more capital, take a lower salary, or carry more operational risk. The agreement should reflect the actual deal, not just the handshake version of it.
How Decisions Are Made
The agreement should specify which decisions require unanimous consent, which require a majority vote, and which a single manager can make unilaterally. Buying equipment might be a manager call. Admitting a new member might require everyone to agree. Selling the company probably requires unanimous consent.
Get specific. “We’ll figure it out together” is not a governance structure.
How Profits and Losses Are Distributed
Here’s something most people don’t know: profit distribution doesn’t have to match ownership percentages. You can give someone 30% equity but only 10% of annual profits. You can give a co-founder a larger share of early profits to compensate for taking a smaller salary during the startup phase. These arrangements are legal, but they only hold up if they’re written down.
The agreement should also specify timing. Are distributions made quarterly? Annually? On-demand when the company has excess cash? Left undefined, this question can become a source of genuine conflict.
Member-Managed vs. Manager-Managed
In a member-managed LLC, every owner has a say in day-to-day operations. In a manager-managed LLC, operational authority belongs to one or more designated managers, while other members are passive. If you have investors or silent partners who contributed capital but don’t run the business, manager-managed keeps them from having operational voting rights while still giving them their ownership stake and distributions.
Most small, founder-run companies are member-managed. Once outside money enters, this question becomes more important.
What Happens When Someone Wants Out
This is where operating agreements earn their keep, and where businesses without them fall apart.
If a member wants to leave, can she sell her ownership stake to anyone? To outside parties? Only to existing members? At what price? Determined by whom? The operating agreement should specify a buyout process, a valuation method, and a timeline. It should also address what happens if a member dies, becomes incapacitated, or goes through a divorce (in many states, a spouse can claim ownership rights to business equity without a proper agreement in place).
Without these provisions, a departure that should take weeks can take years.
Admitting New Members
How does a new member join the LLC? What does the approval process look like, what do they contribute, and how does their admission affect existing ownership percentages? These questions need answers before the conversation with a potential new member, not during it.
Dissolution
What triggers the end of the company, and what happens to remaining assets when it does? Defining this in advance means everyone knows the endgame before it becomes emotional.
The Real Cost of Skipping It
Two women start a skincare brand together. They split it 50/50, shake hands, and get to work. The business grows to seven figures in revenue. After a few years, one founder wants to sell her stake and exit. The other doesn’t want a stranger in the business and doesn’t have the capital to buy out her partner at a fair valuation. There’s no process for resolving this. No method for setting a price. No mechanism for either of them to move forward.
What should be a business transition becomes a lawsuit. Two women who built something real together spend the next two years in litigation instead of working.
This is not an unusual story. Attorneys who specialize in small business disputes will tell you that the majority of cases they see involve partners who had no written agreement about what happens when the partnership ends.
How Much It Costs
For a single-member LLC, free templates from your state’s Secretary of State website or services like Rocket Lawyer ($20-50) are sufficient. The document is mostly a formality for a solo founder, and the template handles the basics.
For a multi-member LLC, hire an attorney. A custom operating agreement typically costs $500-2,000 depending on complexity and your market. That is not a lot of money to spend on a document that governs a business you’re building for years. If your partnership terms are unusual (asymmetrical profit distributions, vesting schedules, complex buyout provisions), pay for complexity. A template agreement that doesn’t capture your actual deal is almost worse than no agreement at all, because it creates the illusion of protection you don’t actually have.
When to Update It
An operating agreement that reflects the past is a liability. Update it whenever ownership changes, a new member is admitted, distribution terms are renegotiated, or someone exits. Keep a version log and make sure every member signs off on amendments.
If your company has grown significantly but your operating agreement was written when you were two people sharing a studio apartment and a dream, it probably doesn’t reflect your current reality. Review it.
Sources
- U.S. Small Business Administration, “LLC Operating Agreements,” 2024. Overview of operating agreement requirements by entity type.
- NOLO, “The LLC Operating Agreement,” 2022. State-by-state requirements and what to include.
- Cornell Law School Legal Information Institute, “Operating Agreement”. Legal definition and member vs. manager-managed structures.
- IRS, “Limited Liability Company (LLC)”. Pass-through taxation and how operating agreements affect tax classification.
- Rocket Lawyer, “Single Member LLC Operating Agreement”. Template costs and what’s covered for single-member LLCs.