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If you are here to learn how to draft an Operating Agreement for a California limited liability company (LLC), it means that you are well on your way to forming a company, having filed your Articles of Organization with the state or in the process of filing. But what is an Operating Agreement?
It is a binding document that establishes the rules to manage the company’s internal affairs according to the wishes of the owners. It also lists the rights and responsibilities of the members of an LLC. Owners of an LLC are called members.
California is one of the few states that legally require an LLC to have an Operating Agreement. It’s recommended that you have a completed Operating Agreement within 90 days after filing the Articles of Organization.
If you are eager to get started, below are details for putting together a California Operating Agreement. Find out why you need it, what needs to be included, and how to draft one.
If you plan to form an LLC in California, one of the requirements is to create an Operating Agreement. This document will serve as a contract among members of an LLC and detail the affairs of the company. The Operating Agreement is a legal document. As such, it needs to be kept with the company records.
The Operating Agreement is important, not only to the day-to-day operations of your business. It also offers solutions to future issues regarding management procedures, profit distributions, and the company’s dissolution. It can be customized according to the needs of the members and business.
Here are some points of interest you can address in your California LLC Operating Agreement:
A California LLC Operating Agreement is not filed with the Secretary of State, and there are no fees to be paid. But as you set up your Operating Agreement, you can file your first Statement of Information. This document is due within 90 days after you’ve filed your Articles of Organization, around the same time that the state expects you to have a completed Operating Agreement.
The Statement of Information is the equivalent of a biennial report for your business. You will have to submit one every two years. In California, the filing fee for the Statement of Information is $20. Online submissions and PDF copies for mail-in submissions are available through the Secretary of State website.
You have to comply with this state requirement; otherwise, noncompliance will mean penalties, and your business will no longer be in good standing, which could lead to the suspension of your licenses and the business as a whole.
An LLC, as a business structure, is great for its flexibility. An LLC can be owned by a single person, two or more owners, or a combination of individuals and companies. But, unlike corporations, it’s not required to hold annual meetings or keep written minutes.
To comply with the law and take advantage of the flexibility of an LLC in California, you need to create an Operating Agreement for your business.
What are the benefits of a California Operating Agreement?
It gives your business legitimacy: An Operating Agreement adds a level of professionalism to your company. Banking institutions will often ask to see your Operating Agreement before allowing you to open a business bank account. And you will have more credibility when applying for loans or asking investors to fund your business if you can show a comprehensive Operating Agreement.
Every person is unique, so it follows that every business and partnership will also have differing needs. The purpose of an Operating Agreement is to address those distinct needs.
However, there are still some points that most Operating Agreements should cover. Here are some guidelines on how to draft a California Operating Agreement.
Some items you may want to include in your California Operating Agreement are:
This section of the Operating Agreement will include basic information about your company, similar to what you provided in the Articles of Organization.
This should include:
The Operating Agreement must explain how the ownership of the company is divided. The portion of the company that a member owns is called their “ownership interest,” “ownership percentage,” or “ownership units.”
If you are a single-member LLC, you own 100% of the business. Owners of a multi-member LLC can adopt an equal ownership structure or assign percentage or units of ownership. Equal ownership means members will own the same percentage of the business regardless of their capital contribution.
On the other hand, multi-member LLCs may decide to assign a percentage of ownership according to members’ capital contributions or involvement in the business operations. For example, let’s say an LLC has three members, and the company needs an initial capital of $10,000. You contribute $5,000, while the other two members contribute $2,500 each. Under this arrangement, you would own half of the company, and they will each own 25%. This is not the only metric you can use for LLC ownership, though.
As stated in the California Revised Uniform Limited Liability Company Act , the default form of management is “member-managed.” This means that all the members mutually decide on business decisions.
Many LLCs prefer to be member-managed, especially if they only have a few members and they’re all involved in the daily operations of the business.
LLCs with relatively large numbers of members often prefer a manager-managed company, mostly because it is more efficient and effective on the day-to-day operations if only one or more appointed managers make the decisions. These managers can be members, someone hired from outside the LLC membership, or both. Your Operating Agreement needs to explain the qualifications of a manager and the procedures to appoint the replacement.
You may include management-related items in your agreement such as:
Make sure to address all these issues and other matters relevant to your company in the Operating Agreement so that your LLC is managed the way you want it to be.
Even though an LLC is not required to hold and keep detailed minutes of meetings, it is still necessary for the owners to meet to discuss the company’s management, plans, and goals regularly.
To avoid future discord, you are strongly encouraged to include the following in your California LLC’s Operating Agreement:
If you are a single-member LLC, you only need to state that you are the decision-maker and representative of your company.
In a member-managed LLC, the voting powers of the members are typically equal to their ownership interest or percentages. This means that a vote from a member with a 50% interest in the business counts as two, while a vote from a member with 25% interest counts as one. And if you decide to give members equal voting powers regardless of ownership interest, it should also be specified in the Operating Agreement. You can use any metric you wish, though.
There may be more rules on membership voting with a manager-managed LLC. You may need to add how managers are selected and the nature of decisions that they can make for the business without approval from the members.
This section of your Operating Agreement will account for each member’s investment in the business. You may include the cost of your startup expenses, too.
Even though most investments are in the form of cash, members may also gain interest in the business by contributing property or services. If this is something the members of your LLC have agreed on, it needs to be laid out in the Operating Agreement.
Your Operating Agreement should detail each member’s initial contribution, ownership percentage, and how profits are distributed. One option is to distribute profits evenly. But anything that you mutually agree on as members of the LLC will be upheld as long as it’s in writing, detailed in the Operating Agreement, and within the boundaries of the law.
For example, you can put in writing that members of the LLC will receive profits calculated according to their ownership percentage in the business, and the amount will be deposited at their respective personal accounts at the end of every calendar year. If your LLC accepted cash, property, or service contributions, you might also choose to compensate members who contributed cash by giving them a higher percentage on the income until their investments are repaid.
It’s also important to spell out how the profits will be distributed, who is responsible for doing so, and how often.
To be truly comprehensive, your Operating Agreement needs to cover the steps for transferring ownership and roles if a member leaves the company.
If a member decides to leave the company, they can transfer all or a percentage of their membership to another member or sell their portion of the LLC to other members, individuals, or companies. The Operating Agreement must include guidelines if current members will be given the right of refusal before the sale is offered to external buyers. Also, describe the conditions for a membership sale.
In addition, the Operating Agreement must have provisions if a member dies or becomes incapacitated. It should provide details on how the ownership interest will be distributed or if members are allowed to transfer ownership to their estate or legal representative.
The procedure of a member’s formal withdrawal from the LLC should also be outlined in the agreement, which may include:
Even at the start of building your California LLC, you should think about the possibility of expanding your business to welcome new members and preparing for worst-case scenarios, such as a member’s death or incapacity.
Your Operating Agreement clarifies, in advance, what will happen to the business if any of these events should happen:
To get started with the buyout or buy-sell rules that you may want to include in your Operating Agreement, answer these questions:
If you are a multi-member, manager-managed LLC with specific and detailed buyout provisions, you may create a separate buyout agreement among the members. As always, consult a business lawyer familiar with your state and industry to ensure all relevant points are covered.
LLCs, unlike corporations, are not obligated by law to hold shareholder meetings. But your company, whether it’s going to be manager- or member-managed, will need to meet and vote on major business decisions.
Putting in guidelines such as who can call a meeting, where meetings will be held, and how often they should happen in your Operating Agreement will save you time in the long run. You can hash out the procedures now and set clear expectations for members.
A California LLCs life is perpetual. But a time may come when members no longer want to continue with the business, or your business may have a specific purpose, and achieving that purpose means the dissolution of the company.
Either way, partnerships and businesses sometimes come to an end. You have to be prepared for that eventuality. A clear outline of the dissolution of the company will make the process less confusing and probably less expensive, as well.
You should also include a guideline for winding up the business’s affairs because neglecting to resolve or pay off all outstanding debts and obligations of the LLC may result in the members becoming personally responsible to the LLC’s creditors.
Examples of reasons that may cause a dissolution of an LLC include:
What are the steps necessary to dissolve an LLC?
Even if you don’t want to think about closing your business because you are still in the formation stage, you should anticipate and prepare for the possibility. Making sure you add clauses to your Operating Agreement to that effect will make the process easier when the time comes.
If you are the owner of a single-member LLC, it may seem that most of the inclusions discussed do not apply to you; however, there are relevant points you should still address.
For example, as the only member of the LLC, it is implied that you make all the business decisions for the company. But to be clear of legal technicalities, it would benefit you and the business if this is clearly stated. Specify that you are the sole representative of the company and have the authority to act on its behalf in all business dealings.
It’s important to have this expressly written because if you take certain actions without it in your Operating Agreement, it may become a loophole that your creditors can use to hold you
personally accountable for the liabilities of the company.
Secure your company and avoid headaches by ensuring that your Operating Agreement is tailored to your company’s needs. And as your business grows, make sure to keep it updated.
The last section of your LLC Operating Agreement should be a severability clause. This is a common legal boilerplate used in documents. It states that if a portion of the agreement proves to conflict with the state or federal law, all other parts should still be in effect. Including this clause ensures that small errors or inaccuracies won’t invalidate the whole agreement.
Are you overwhelmed by everything you’ve just read about drafting your Operating Agreement? Don’t worry. ZenBusiness can make the process simpler with our existing Operating Agreement template.
However, as every business is one of a kind, it’s still recommended that you consult a legal professional before signing your Operating Agreement.
One of the benefits of an LLC as a business structure is its flexibility. As your company grows, you may add more members or change your tax election. Either way, these warrant an amendment to the Operating Agreement.
Ideally, you’ll want to review your Operating Agreement yearly to make sure that it still represents your wishes regarding the operation of your business and that it still covers all the areas where you want to override the default laws set by the state.
You will need to update it after any important company events, such as:
And depending on your initial Operating Agreement, you may need all or some of the members to approve any changes to the document. You also need to have all the changes in writing and the amended Operating Agreement signed by all members to be binding.
It is also worth noting that any changes to the name of the LLC and the company’s management structure need to be reported to the California Secretary of State by submitting an Amendment to the Articles of Organization and paying the $30 filing fee.
Changes to the company’s addresses, names of members or managers, or registered agents will need to be done by filing the biennial Statement of Information and paying the $20 fee. If filing this biennial report between the normal filing times, there’s no fee.
If you want to change or amend stipulations in your Operating Agreement, it is always advisable to consult with professionals well-versed in the laws of the state where your company does business. This is also necessary because states update and revise their corporation codes, meaning laws could change, and it could cause your company to be noncompliant with current regulations.
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