Posted by Jennifer M. Settles, Esq. | Apr 30, 2025

The Need for a Carefully Written LLC Operating Agreement

LLC Operating Agreements (OAs) are vital documents that outline the rights, responsibilities, and governance structure of the business. Whether you’re forming a new LLC or updating an existing one, drafting a comprehensive OA is crucial to avoid misunderstandings and conflicts among members. A carefully written OA is especially important where the LLC has more than one member or when additional members are anticipated for the future. This includes friends and family equity investors, third party investors, a Seller equity roll-in, or an earnout payable to a Seller involving Buyer equity. On the other hand, if the LLC is a single-member LLC and is intended to stay that way, then a careful and detailed OA is much less critical.

In this Blog post, we’ll explore 15 important provisions that every LLC should consider including in its Operating Agreement.

15 Important Provisions for an Operating Agreement

Management and Governance

1. Governance and Management Rights. The OA should clearly define the management structure of the LLC, including whether it will be member-managed or manager-managed, consistent with the formation of the entity itself. The OA needs to specify the powers and duties of managers and members, decision-making processes, and any limitations on authority.

2. Voting Requirements. Identify the voting thresholds required for various decisions, distinguishing between whether a member has a vote at all as to a particular topic, and whether majority and supermajority voting requirements apply. Major decisions such as amending the OA, admitting new members, selling material assets, or dissolving the LLC may require a higher threshold to ensure consensus among members.

Financial Provisions

3. Distributions. Outline the authority, criteria and timing for distributions to the members. Specify whether distributions will be made pro-rata based on ownership percentages or according to other criteria outlined in the OA. If one member (or member class) has special rights, it often appears in the distribution section.

4. Capital Contributions. Detail the initial capital contributions required from each member, whether additional capital calls can be made, and if so, the process for doing so.

5. Preferential Rights. If certain classes of membership interests have preferential rights, such as priority in distributions or liquidation proceeds, clearly define these rights in the OA to avoid ambiguity or disputes later.

Transfer and Buy-Sell Rights

6. Transferability of Interests; Buy/Sell Provision. Include provisions describing the ability or restrictions on the members to transfer their membership interests. Additionally, the OA may include a detailed process for one member to buy out another member, including timing and pricing, such as a put or call provision, transfers upon death or disability of a member, and drag-along and tag-along rights.

7. Right of First Refusal (ROFR). As part of the transferability provisions, consider including a ROFR to give existing members the opportunity to purchase a selling member’s interest before the interest is offered to outsiders.

Succession and Tax

8. Management succession. The OA should include the process for removing a manger, handling manager succession, and the handling of manager vacancies.

9. Tax Allocations; Tax Provisions. Establish the method for allocating profits and losses among members. This may include provisions for special allocations to accommodate members’ tax preferences or obligations. That said, tax allocations must have substantial economic effect in order to satisfy Internal Revenue Code (IRC) requirements. An OA should also identify the “partnership representative” (the individual authorized to represent the company before tax proceedings), and typically includes various special provisions and regulatory allocations called for under the IRC.

Legal Standards and Records

10. Fiduciary Duty Standards. Define the fiduciary duties owed by members and managers to the LLC and its members. These duties typically include the duties of loyalty and care, outlining the standard of conduct expected in managing the affairs of the LLC. Consider whether to defer to state law standards, or to alter or waive the fiduciary standards per special terms added to the OA.

11. Books and Records. The OA should contain details as to the obligation of the company to maintain books and records, and the ability of the LLC members to access copies of those records in accordance with state law.

Administrative Provisions

12. Amendment Procedures. The OA should discuss the process for how to amend the OA, including the percentage interest needed to approve the amendment and any prior notification requirements.

13. Confidentiality, Noncompete; IP. A well-written OA should also include any obligations regarding confidentiality, member non-competition with the LLC, as well as assignments of any intellectual property rights obtained or developed by members for the company in their individual capacities.

14. Indemnification; insurance. The OA should outline the scope of the company’s duty to indemnify (and in some cases defend) its members and managers, as well as the authority for the company to buy D&O (and other) insurance.

15. Dissolution. The OA should include provisions addressing dissolution of the company, including what triggers a dissolution, and the process for winding up and liquidating the company.

Conclusion

Drafting a comprehensive LLC operating agreement that addresses the key provisions listed above can help protect the interests of all members and promote the smooth operation of the LLC.

Unlike corporations, the governance of LLCs is dictated by the terms of its governing contract (ie, its Operating Agreement). By being able to contractually select the entity’s governance terms, LLCs and their members and managers have tremendous flexibility – which is one of the main reasons why LLCs are such a popular entity choice. Also, an Operating Agreement is a living document that can be amended as needed, especially as the business grows and evolves. Regular review and updates to the OA can help keep your LLC in compliance with changing regulations, help attract investors, and better position your company for long-term success.

Consulting with legal counsel experienced in business law and LLC formation is advisable to ensure that your OA complies with state laws and reflects the unique needs and objectives of your business. The Law Office of Jennifer M. Settles represents JV partners and LLC members in the negotiation of LLC operating agreements. Contact us today at (602) 617-3938 for more information and to schedule a FREE consultation.