What a good operating agreement actually does
The generic operating agreement you get from an online filing service — or worse, no operating agreement at all — treats the LLC as if the founders will never disagree, never want out, never die unexpectedly, never bring in new members, and never fight over how profits get distributed. Every real business hits several of those situations.
A properly drafted operating agreement is essentially a contract between the members that answers, in advance: what happens when someone wants out, what happens when someone dies or becomes disabled, how new members get admitted, how profits get distributed vs. reinvested, how deadlocks between members get resolved, what happens if a member breaches, and what triggers a mandatory buyout.
The document is boring to read but foundational when the situation actually arises. Businesses without one are usually one bad conversation away from either dissolution or expensive litigation.
Multi-member LLC operating agreements
Standard scope for a multi-member LLC agreement:
- Member interests and capital contributions — who owns what percentage and what they contributed to earn it
- Management structure — member-managed vs. manager-managed, with named managers and their scope of authority
- Profit and loss allocation — pro rata by ownership vs. custom allocation, with tax-driven special allocations if warranted
- Distributions — mandatory tax distributions, discretionary distributions, priority returns for capital, waterfalls if warranted
- Member decision-making — what requires unanimous consent, what needs a majority, and what the managers can do unilaterally
- Buy-sell provisions — the mechanics that trigger when a member wants out, dies, or becomes disabled (see below)
- Transfer restrictions — right of first refusal, tag-along and drag-along provisions, approval requirements for outside transfers
- Deadlock resolution — mediation, third-party appraisal, shotgun clause, or dissolution triggers when members cannot agree
- Dissolution mechanics — what triggers dissolution, how assets get distributed, how liabilities get satisfied
Partnership agreements
For general partnerships and limited partnerships. Similar scope to LLC operating agreements but with additional considerations for partner liability, capital account maintenance under partnership tax rules, and the different management structures required for LPs.
Corporate bylaws and shareholder agreements
For C-Corps and S-Corps. Bylaws govern the internal operating rules (board meetings, officer roles, corporate formalities). Shareholder agreements govern the relationship between owners — same substantive topics as LLC operating agreements (transfer restrictions, buy-sell, drag-along, tag-along) but in the corporate framework.
Buy-sell provisions and exit mechanics
The most important — and most-overlooked — part of any governance document. Buy-sell provisions define what happens when a member wants out, dies, becomes disabled, files bankruptcy, or is terminated for cause. Poorly drafted buy-sell terms are the #1 source of ownership disputes in closely-held businesses.
- Triggering events — voluntary exit, death, disability, retirement, termination, divorce, bankruptcy
- Valuation methodology — formula (EBITDA multiple), appraisal, negotiated, or specified price. Each has tradeoffs.
- Payment terms — lump sum vs. multi-year note; interest rate; security
- Funding mechanism — company funds, life insurance on key members, cross-purchase between remaining owners
- Right of first refusal vs. mandatory buyout — whether the remaining members must buy or merely have the option