You just formed your LLC. Congratulations! Now someone mentions you "need" an "operating agreement."
You Google it, find a free template, fill in your names, and call it done. Or maybe your online formation service included a generic one that you never actually read. Problem solved, right?
Not quite.
Here's what most founders don't realize:
Operating agreements are often more important than Articles of Organization. They serve as the constitution of a business—the document that actually governs how a company operates, how decisions get made, and what happens when things go wrong.
And a generic template? It's like using a one-size-fits-all prenup. It might cover the basics, but it typically won't address specific situations, equity structures, decision-making needs, or plans for the future.
Let me show you why LLCs often benefit from more than a template—and what a comprehensive operating agreement typically includes.
What Is an Operating Agreement (And Why It Matters)
An operating agreement is the internal rulebook for an LLC. It typically establishes:
- Who owns what - Ownership percentages and membership interests
- How money works - Capital contributions, profit distributions, and loss allocation
- How decisions get made - Voting rights, approval thresholds, and management structure
- What happens when - Death, disability, divorce, disagreement, departure, or dissolution
- How to change things - Amendment procedures and major decisions
Here's the key thing: Most of this information is NOT in the Articles of Organization filed with the state.
Those public documents contain the bare minimum. Operating agreements contain the details that often matter most in day-to-day operations.
Do You Legally Need One?
It depends on your state:
Some states legally require operating agreements (as of this writing, states like California, Delaware, Maine, Missouri, and New York have such requirements, though laws change frequently). Most states don't require them but commonly recommend them.
But here's the real question: Do you want your LLC governed by your state's default rules, or by rules you chose?
Without an operating agreement, your state's LLC statute provides default rules. These generic rules:
- May not match your intentions
- Can't anticipate your specific situation
- Don't address vesting, buy-sell provisions, or deadlock scenarios
- Often favor equal distribution regardless of actual contributions
Even in states that don't require an operating agreement, many founders choose to have one.
Why Templates Fall Short: The Generic Agreement Problem
Let's look at what a typical low-cost online template provides:
Standard template provisions:
- Basic ownership percentages
- Generic management structure language
- Standard profit distribution (usually pro-rata by ownership)
- Boilerplate dissolution language
- Generic meeting and voting provisions
What templates often DON'T include:
- Vesting schedules for founder equity
- Buy-sell provisions for departing members
- Deadlock resolution mechanisms
- Right of first refusal for ownership transfers
- Non-compete and non-solicitation provisions
- IP assignment requirements
- Capital call procedures
- Customized voting thresholds for major decisions
- Specific roles and responsibilities
- Dispute resolution procedures
Real Scenario: When Templates Fall Short
Two co-founders, 50/50 split, using a generic template:
Month 6: Co-Founder B stops working on the business but refuses to give up their 50% ownership.
With Generic Template:
- Co-Founder B keeps 50% forever
- They can block all major decisions
- Co-Founder A can't remove them
- Difficulty raising money with this situation
- Must negotiate expensive buyout or dissolve company
With Comprehensive Operating Agreement Including Vesting:
- Co-Founder B's equity vested only 12.5% (6 months of 4-year vesting)
- Remaining 37.5% returns to company
- Co-Founder A can continue business
- Clean cap table for investors
The cost difference: Attorney fees for a proper agreement typically range from hundreds to several thousand dollars, while fixing disputes later can cost tens of thousands or more (if fixable at all). Costs vary widely by jurisdiction, complexity, and attorney.
What a Comprehensive Operating Agreement Typically Covers
Let me break down the sections that operating agreements commonly include:
1. Organization and Formation
Basic information:
- LLC name and formation date
- Principal place of business
- Registered agent information
- Business purpose (can be broad)
Why it matters: Establishes the foundational details and helps ensure everyone understands what business operations are contemplated.
2. Members and Ownership Structure
Critical details:
- Who are the members?
- What percentage does each member own?
- What did each member contribute (cash, property, services)?
- Initial capital contributions and valuation
- Classes of membership (if applicable)
Template limitation: Templates use placeholder percentages. But founders often benefit from discussing different capital contributions, time commitments, skill sets, and sweat equity vs. cash investment.
3. Vesting Schedules (Particularly Important for Multi-Member LLCs)
What is vesting? Vesting means members "earn" their ownership over time, typically 4 years. If someone leaves before fully vesting, they only keep what they've earned.
Common vesting structure:
- 4-year vesting period
- 1-year cliff (nothing vests until 1 year)
- Monthly or quarterly vesting thereafter
Why founders often include it: Without vesting, someone can join a company, receive significant ownership, leave after a short time, and keep that ownership. They can potentially block decisions, complicate fundraising, and create legal issues. Vesting is designed to protect against this.
What templates often miss:
- Acceleration provisions (what happens in acquisition or termination?)
- Reverse vesting mechanics
- How unvested shares are handled
- Service requirements for vesting
4. Capital Contributions and Accounts
Initial contributions:
- How much did each member contribute?
- In what form (cash, equipment, IP, services)?
- How was non-cash contribution valued?
Future contributions:
- Can the LLC require additional capital contributions?
- What happens if a member can't or won't contribute?
- Does their ownership get diluted?
Template limitation: Most templates say "members contributed $X" with blanks. But what if contributions were unequal? What if one contributed money and another contributed services? What if additional money is needed next year?
5. Profit, Loss, and Distribution Allocation
Key questions:
- How are profits and losses allocated?
- How often are distributions made?
- What percentage of profits must be distributed vs. retained?
- Do all members receive distributions proportionally?
- What if the LLC doesn't have cash to distribute?
Important distinction: Ownership percentage doesn't always equal profit distribution percentage.
Example scenario:
- Member A: 60% ownership, contributed $150K cash
- Member B: 40% ownership, contributed $50K cash + sweat equity
Operating agreements can be structured with provisions like:
- Tax allocations: 60/40 (by ownership)
- Cash distributions: 75/25 until initial capital is returned, then 60/40
- Profit priority: First $200K to Member A, then 60/40
Template limitation: Templates default to simple pro-rata allocation. This might not reflect the actual economic arrangement founders intend.
6. Management and Voting
Management structure:
- Member-managed: All members participate in management and have authority to bind the LLC (like a partnership).
- Manager-managed: Members appoint one or more managers who run the business; members don't have day-to-day authority.
Voting rights:
- One vote per member, or votes proportional to ownership?
- What decisions require unanimous approval?
- What decisions require majority approval?
- What decisions can managers make alone?
Decisions that often require specific approval thresholds:
- Selling the company
- Taking on debt over $X
- Hiring/firing key executives
- Making capital expenditures over $X
- Admitting new members
- Amending the operating agreement
- Changing business direction significantly
- Entering into contracts over $X
- Distributing profits
Template limitation: Templates provide generic voting rules that may not match specific needs. If there's a 50/50 split, how are deadlocks resolved? If there are three members at 40/30/30, who controls decisions?
7. Meetings and Procedures
Provisions commonly included:
- How often do members meet?
- How are meetings called and noticed?
- What constitutes a quorum?
- Can members vote by written consent instead of meeting?
- Are virtual meetings permitted?
- What records must be kept?
Practical reality: Small LLCs don't typically hold formal meetings. But documentation for major decisions is often advisable. Operating agreements commonly specify:
- When formal approval is required
- How to document decisions (written consent, email, etc.)
- What gets recorded in meeting minutes
8. Transfer Restrictions and Buy-Sell Provisions
This is where most templates have significant gaps.
Transfer restrictions:
- Can members freely sell their ownership?
- Right of first refusal (company or other members get first chance to buy)
- Right of co-sale (if one sells, others can join the sale)
- Drag-along rights (majority can force minority to join in sale)
- Tag-along rights (minority can join if majority sells)
Buy-sell provisions for involuntary departures:
What happens if a member:
- Dies?
- Becomes disabled or incapacitated?
- Gets divorced (and spouse wants their share)?
- Goes bankrupt?
- Wants to leave the company?
- Is terminated for cause?
- Violates company policies?
Without these provisions:
- Dead member's spouse or estate owns their shares
- Disabled member retains ownership but can't work
- Divorcing member's spouse becomes a member
- Departed member can block all decisions
- Difficulty removing problematic actors
What's often beneficial:
- Triggering events that require or permit buyout
- Valuation method (book value, fair market value, formula, appraisal)
- Payment terms (lump sum, installments, promissory note)
- Funding mechanism (company funds, life insurance, member buyout)
Example provision: "If a member voluntarily resigns, the company has the option (but not obligation) to purchase their membership interest at book value, payable over 24 months at 5% interest. If the company declines, remaining members can purchase pro-rata."
9. Deadlock Resolution
The 50/50 challenge:
Two members, equal ownership, can't agree on a major decision. Without a tiebreaker mechanism, the situation can become problematic.
Deadlock resolution options commonly seen:
- Third-party tiebreaker - Bring in advisor, board member, or mediator
- Buy-sell shootout - One member names a price, other chooses to buy or sell at that price
- Dissolution - If can't agree, wind down the business
- Mediation/arbitration - Required dispute resolution before litigation
Template limitation: Templates rarely include deadlock provisions, leaving no clear mechanism to resolve fundamental disagreements.
10. Non-Compete and Non-Solicitation
Protection provisions commonly included:
- Members can't compete with the LLC while members
- Members can't compete for X years after leaving (enforceability varies significantly by state)
- Members can't solicit customers or employees after leaving
- Members can't use confidential information
Why founders often include these: Without these provisions, a member can potentially leave and immediately start a competing business using customer lists and hiring employees.
Important note on state law variation: Non-compete enforceability varies dramatically. California generally won't enforce them. Other states will enforce if reasonable in scope, duration, and geography. As of this writing and subject to change, enforceability remains highly jurisdiction-dependent.
11. Intellectual Property Assignment
Common provision: All IP created by members in connection with the business belongs to the LLC, not the individual member.
What this typically covers:
- Code, software, and technology
- Trademarks, logos, and branding
- Processes and methods
- Customer lists and business information
- Anything developed for the business
Template limitation: Templates often omit IP assignment or use vague language. Without clear assignment, a departing member might claim they own software they wrote or branding they designed.
12. Confidentiality and Fiduciary Duties
Confidentiality: Members must keep business information confidential, during and after membership.
Fiduciary duties:
- Duty of loyalty - Act in best interest of company, not personal interest
- Duty of care - Make informed decisions with reasonable diligence
- Duty of good faith - Deal honestly and fairly
Can you modify these? Some states allow operating agreements to modify or eliminate certain fiduciary duties. Whether this is advisable is a complex question that typically requires legal advice.
13. Amendment and Dissolution
Amendment:
- What vote is required to amend the operating agreement?
- Are certain provisions unamendable without unanimous consent?
- How are amendments documented?
Dissolution:
- What events trigger dissolution?
- How is dissolution vote taken?
- How are assets distributed?
- Who handles winding up?
14. Dispute Resolution
Litigation can be expensive. Many founders choose to include:
- Mediation first - Neutral third party helps negotiate resolution
- Arbitration - Binding decision by arbitrator instead of court
- Attorneys' fees provision - Prevailing party recovers legal costs
Single-Member LLCs: Is an Operating Agreement Beneficial?
Many attorneys recommend having one. Even if you're the only member, an operating agreement can be beneficial because:
- Proves separation - Demonstrates your LLC is separate from you personally (strengthens liability protection)
- Banking requirements - Many banks require operating agreements to open business accounts
- Credibility - Shows you run a real business, not just a shell
- Multiple members later - When you add members, you'll benefit from having one anyway; easier to have framework from start
- Estate planning - Documents what happens if you die or become incapacitated
Single-member operating agreements commonly cover:
- Your ownership and capital contribution
- Management structure and powers
- How profits are handled
- Succession planning (what happens to LLC if you die)
- Your own obligations and standards
Multi-Member LLCs: Widely Considered Essential
If you have partners, a comprehensive operating agreement is widely considered essential in business practice.
The statistics are sobering:
- A significant percentage of startups face challenges due to co-founder conflict
- Many conflicts arise from unclear expectations about roles, equity, and decision-making
- Courts enforce (or void) what parties have agreed to
What commonly causes co-founder disputes:
- Unclear equity splits
- No vesting (someone leaves but keeps equity)
- Unequal time commitments
- No process for removing problematic actors
- Disagreement about company direction
- Financial stress and distribution disputes
A comprehensive operating agreement is designed to prevent many of these disputes.
The Real Cost of Inadequate Documentation
Scenario 1: No Operating Agreement
Two founders split 50/50. One leaves after 6 months but retains 50% ownership. Remaining founder:
- Can't make major decisions alone
- Faces challenges bringing on investors (investors typically won't invest with this problem)
- Can't remove departed founder
- Must negotiate buyout (which can be expensive) or dissolve
Cost to address: Legal fees, buyout costs, or lost business value can range from tens of thousands to over one hundred thousand dollars, depending on circumstances.
Scenario 2: Generic Template
Three founders use free template. Didn't address:
- Different capital contributions ($100K vs. $20K vs. $0)
- Different time commitments (full-time vs. part-time vs. advisor)
- Decision-making for 33/33/33 split (how to break ties?)
18 months later: Dispute over whether to take funding and who has authority to decide. Legal issues ensue.
Cost: Legal fees can reach tens of thousands of dollars or more, relationship potentially destroyed, company damaged
Scenario 3: Comprehensive Operating Agreement
Same three founders invest in attorney consultation to create proper operating agreement:
- Clear equity split with vesting
- Voting procedures for deadlocks
- Buy-sell provisions
- Defined roles and expectations
When disputes arise: Agreement provides framework to resolve. Everyone knows the rules. Issues often get worked out without extensive litigation.
Cost: Attorney fees commonly range from hundreds to several thousand dollars upfront (varying widely by jurisdiction and complexity). This investment can potentially save tens of thousands in dispute resolution later.
When to Create Your Operating Agreement
Commonly recommended timing: Within 30 days of formation, and ideally before:
- Accepting capital contributions
- Issuing membership interests
- Making significant business operations decisions
- Signing contracts or leases
- Hiring employees
- Opening business bank accounts
Why timing matters:
- Easier to negotiate when everyone's excited - Before problems arise, everyone's typically reasonable
- Sets expectations early - Helps prevent future disputes about "what we agreed to"
- Required for banking - Can't open business account without one at many banks
- Protects from day one - Liability protection strengthened by having agreement in place
Late is better than never: If you already formed your LLC without an operating agreement, creating one now can still be beneficial.
Template vs. Attorney: Common Patterns
Founders sometimes rely on templates when:
- Single-member LLC
- No plans to add members
- Simple structure and operations
- No significant assets
- Lower-risk business
- They understand every provision in the template
Attorneys are commonly engaged when:
- Multiple members/founders
- Unequal contributions (money, time, skills)
- Complex equity arrangements
- Vesting schedules needed
- High-value business or significant investment
- Specific industry considerations
- Non-standard voting or management structures
- Previous disputes between members
- Family members as members
Attorney fees for operating agreements commonly range:
Costs vary widely by jurisdiction, complexity, and attorney rates in your area.
Consider this: Founder disputes and buyout litigation can cost tens of thousands to over one hundred thousand dollars. The operating agreement functions as protection against potentially catastrophic business failure.
Red Flags in Template Operating Agreements
Watch out for these issues:
How to Create a Comprehensive Operating Agreement
Step 1: Discuss Key Issues With All Members
Before drafting, founders benefit from having honest conversations about:
- Why these ownership percentages?
- What if someone wants to leave?
- What if someone isn't contributing as expected?
- How do we make decisions?
- How do we handle disputes?
- What's our exit strategy?
Documenting these discussions helps inform the agreement.
Step 2: Choose Your Approach
Option A: Start with a quality template
- Use state-specific template from reputable source
- Carefully customize for your situation
- Consider having attorney review (costs vary)
Option B: Engage attorney from the start
- Attorney interviews you about business
- Drafts custom agreement
- Explains each provision
- Ensures it matches your deal
Option C: Use online legal service
- Services like Rocket Lawyer or LegalZoom
- Guided questionnaires
- Better than generic templates
- Not as comprehensive as custom attorney work
- Middle ground on cost (varies by service)
Step 3: Cover All Essential Provisions
Use the sections outlined above as your checklist. Operating agreements commonly address:
- Ownership and vesting
- Capital contributions
- Profit/loss allocation
- Management and voting
- Transfer restrictions
- Buy-sell provisions
- Dispute resolution
- IP assignment
- Confidentiality
Step 4: Customize for Your Situation
Rather than accepting generic provisions, founders often benefit from thinking through:
- What makes sense for our business?
- What scenarios might we face?
- What protections do we each need?
- What's fair given our different contributions?
Step 5: Have All Members Review and Negotiate
Everyone typically should:
- Read entire agreement carefully
- Understand every provision
- Ask questions about anything unclear
- Negotiate terms that don't work
- Consider consulting their own attorney for major transactions
Taking time on this is often worthwhile. Better to spend time now than litigate later.
Step 6: Execute Properly
All members must sign:
- Original or counterpart signatures
- Dated
- Notarization (required in some states, check local requirements)
Store securely:
- Keep original with corporate records
- Provide copies to all members
- Provide to your attorney
- Provide to accountant for tax purposes
Updating Your Operating Agreement
Your operating agreement isn't necessarily "set it and forget it." Many founders update when:
Major changes occur:
- Adding or removing members
- Significant capital contributions
- Changing management structure
- Modifying voting rights
- Adjusting profit allocations
- Business pivot or major direction change
Annual review is commonly recommended:
- Still reflects reality?
- Addresses current issues?
- Complies with current law?
- Fair given company growth?
Amendment process: Follow the amendment provisions in your agreement (usually requires member vote). Document amendments in writing and attach to original agreement.
What If You Already Have an Inadequate Operating Agreement?
It can typically be amended or replaced. You can usually amend or replace your operating agreement if all members agree.
Steps commonly taken to improve:
- Identify the problems - What's missing or inadequate?
- Discuss with members - Everyone typically needs to agree to changes
- Draft amendment or replacement - Often done with attorney assistance
- Get unanimous approval - All members must typically sign
- Document properly - Attach amendment to original or replace entirely
Common improvements:
- Add vesting schedules (even retroactively with consent)
- Add buy-sell provisions
- Add deadlock resolution
- Clarify voting procedures
- Update capital contribution terms
- Add IP assignment language
Cost to improve: Often ranges from around one thousand to several thousand dollars depending on complexity and jurisdiction. Generally considered less expensive than litigation.
The Bottom Line
Operating agreements are widely considered among the most important documents for an LLC (after formation documents). Many business advisors consider them more important than websites, business plans, or pitch decks.
Why? Because they govern how a business actually operates, how decisions get made, and what happens when things go wrong—and challenges inevitably arise in business.
A template provides words on paper. A comprehensive operating agreement typically provides:
- Clear expectations and roles
- Protection from partner disputes
- Mechanisms to resolve conflicts
- Tools to handle departures and changes
- Foundation for growth and investment
- Defense against litigation
- Peace of mind
The typical cost of comprehensive documentation:
The potential cost of inadequate documentation:
Many founders choose to invest in a comprehensive operating agreement. The goal is protection when a co-founder quits but can't hold the company hostage, or when a dispute arises and there's a clear roadmap to resolve it.
Templates work well for many purposes. Operating agreements—the constitutional documents of a business—commonly benefit from more careful attention.
Learn more about Business Formation for startups.
Your operating agreement depends on your ownership type — see Single-Member LLC vs. Multi-Member LLC.
If you’re weighing entity choices, read Should Your Startup Be an LLC or Corporation?.
Avoid agreement mistakes by checking 5 Business Structure Mistakes Founders Make.