There’s a lot to keep track of when starting a limited liability company (LLC). You need to choose a good name, make sure you are compliant with all laws, and file your Certificate of Organization to register your business officially with the Pennsylvania Department of State.
However, once the groundwork is done there, don’t overlook the next big step of creating an Operating Agreement. In this article, we will explain in detail what an LLC Operating Agreement is, why you need one, how to create one, and much more.
What is a Pennsylvania LLC Operating Agreement?
If you’ve decided to register your business as an LLC, you are likely aware of the amount of flexibility that business designation comes with. But because of this flexibility, it’s a good idea to decide what rules and procedures will work best for your business early on — so you aren’t faced with questions, difficult decisions, and disagreements down the road.
This is where an LLC Operating Agreement comes in. An Operating Agreement is a document that you create with the other members (owners) of your LLC that outlines all of the details of how to run your business, who is responsible for what, how profits are shared, how changes can be made, and much more.
The idea behind an LLC Operating Agreement is to have a legal foundation for how you want things to work in your business. It provides a reference for how to solve problems and disagreements, and it serves to protect all members and the business itself.
Although LLC Operating Agreements are not legally required in Pennsylvania, it is always good to have one. These agreements are legally binding and will dictate how disagreements might be resolved in court. This is good because, without such an agreement, your business becomes subject to default state laws — which don’t necessarily align with what works best for your business — in such scenarios.
Once you create an LLC Operating Agreement, and all of the members sign it, you should keep this document in a safe place with other important business documents. You are not required to file it with Pennsylvania, but you will need to produce it if you encounter a legal dispute related to something included in it.
Why do I need an LLC Operating Agreement in Pennsylvania?
Going without an Operating Agreement can leave your business open to a whole host of legal troubles. In the absence of an Operating Agreement, all disputes about any aspect of your business will be subject to default state laws or a judge’s decision, as opposed to being subject to the rules that you and your fellow business partners agreed on at the beginning.
Not only that, but the very act of creating an Operating Agreement can streamline the running of your business by allowing you to pin down the details of procedures and plan for all possible issues.
More specifically, the reasons to have an Operating Agreement include:
- Protection of your business’s limited liability status: While LLCs are supposed to limit the liability of the members or owners, it can vary how the laws are interpreted and what liability might end up getting passed through to members in the event of a lawsuit. An Operating Agreement can help clarify which assets are business and which are personal.
- Clarification of verbal agreements: Verbal agreements are great among friends, and when everyone gets along. But memories aren’t always accurate or in agreement with each other, and people have been known to disagree and fall out. Because of this, any verbal agreements about your LLC should be on paper. Specifically, they should be part of your Operating Agreement so that they are legally binding.
- Protection of agreements in the eyes of Pennsylvania: In the absence of an Operating Agreement, your business will be subject to the default state laws, which were written very generally and will not likely align with what is best for your business. Creating an Operating Agreement gives you the chance to decide how things should work for your LLC.
- The flexibility offered by an LLC business type: LLCs are very flexible business types, granting their owners a lot of leeway in how they are run. But this also leaves a lot of open decisions to be made. It’s best to sort out what works for your business early on and establish it in the Operating Agreement. You can always amend your agreement later if needed.
- Ability to open business bank accounts and lines of credit: Many banks and lenders want to see an Operating Agreement before letting a business establish an account with them. This is their way of verifying that the business is well-planned-out, organized, and in a good position to succeed. In particular, if you are seeking loans or money from investors, having an Operating Agreement will legitimize your business in their eyes.
- The right mindset for starting your business: Creating an Operating Agreement is an opportunity to give serious, focused thought on how you want to run your business. This is a great way of getting you in the right mindset for launching your LLC.
What do I include in my Pennsylvania LLC Operating Agreement?
Sometimes, it’s a good idea to brainstorm all sides of your business — what day-to-day tasks must be done? What needs to happen to remain in compliance? What types of decisions will need to be made from time to time, and how should those be handled? The more you can think of, the better.
In this section, we provide many common items to include in an Operating Agreement but don’t consider this to be the end of the list. Depending on your business needs, you may need more. It’s important to include as much detail and cover as many aspects as possible.
Items to include in your Pennsylvania Operating Agreement include:
- LLC Name
- Duties of Members and Managers
- Voting Rights and Responsibilities
- Holding Meetings
- Buyout and Buy-Sell Rules
- Succession Planning
- Modifications to the Operating Agreement
- Single-Member LLC Statute
- Severability Provision
1. LLC Name
Your Operating Agreement should include the name of your LLC. It should be written as it appears in the Certificate of Organization that you filed with Pennsylvania when you registered your business. This also means including the LLC designator that you chose.
Including the name of your LLC in the Operating Agreement isn’t just a practical matter of making it clear which business it applies to, but having the exact legal name is what makes the items in the agreement legally enforceable.
Be sure to include a list of each member’s name — their full legal names and addresses — to establish who is involved. With this list, you should also specify what percentage of ownership each member has.
For example, you may split ownership equally among five members, each owning 20% (the total should always add to 100%), or you may choose to attribute ownership based on capital contribution. For example, if one member contributed 40% of the capital (startup funds), and the other four each contributed 15%, you may want to apply the same percentages to ownership.
You are free to split the ownership any way you want. It doesn’t need to be an equal distribution or tied to capital contributions. The only requirement is that all members agree on it.
3. Management Structure
LLCs can be managed by the members (owners) or by one or more assigned managers who are or are not owners. It is important to decide which one is right for your business and be aware of the legal consequences of your decision.
In a member-managed LLC, the members take on the responsibilities of managing the business and deciding how things work. In a manager-managed LLC, the members delegate their authority to the manager or managers.
Your Operating Agreement should clearly spell out who the managers are, whether one or more of them are members, and what rights the members and managers have in the decision-making process.
4. Duties of Members and Managers
As you list the names of the members and managers, be sure to also include clearly delineated duties, rights, and responsibilities of each. Even if some or all members aren’t involved in the day-to-day business operations, they may still need to attend meetings and participate in voting. This should be included in your Operating Agreement, as well.
5. Voting Rights and Responsibilities
Businesses face decisions all of the time in the normal course of their operation and growth. They may want to add a member, change the management structure, or add an amendment to the initial Operating Agreement, for example.
As such, the Operating Agreement should spell out who has voting rights and whether those votes are equal or apportioned based on ownership or other factors. Sometimes, it makes sense for certain members to be involved in some voting decisions and not others. You may further want to specify which issues members will vote on.
When the business makes money, those profits must be distributed among the members somehow. The procedures for this should be spelled out in the Operating Agreement.
You may wish to share all profits equally among members or in proportion to ownership percentages or capital contributions. There is no right or wrong way to do this. It is entirely up to you but should be aligned with your business’s best interests and agreed on by all members.
This part of the Operating Agreement should additionally spell out how these profits will be distributed. For example, will it happen at the end of the fiscal year? Will members be paid by check or direct deposit? You may also wish to clarify that each member is responsible for paying taxes on any distributions, as LLCs are, by default, pass-through entities (they are not taxed at the business level; instead, members pay personal income tax on their distributions). If your LLC is electing to be taxed as a corporation instead of a pass-through entity, you may want to put that in the agreement.
7. Holding Meetings
How and when your business will hold meetings is also entirely up to you but worth including in your agreement. Regular meetings are often a good idea and provide an opportunity for everyone to check in regularly, discuss any issues that arise, and determine if anything needs to be addressed or changed.
You may additionally include wording to describe situations that merit mandatory meetings — such as for voting on any issues that arise.
If you want attendance to be mandatory, you should include this in your Operating Agreement. Not only does this make expectations clear to everyone, but if certain members refuse to attend or stop participating, you will have legal grounds to hold them responsible and potentially vote them out if necessary.
8. Buyout and Buy-Sell Rules
All businesses evolve, and people’s priorities can change. As a result, it may be necessary to welcome new members or say goodbye to old ones. Your Operating Agreement should clarify the process by which this can happen.
If a member wants to leave, but they have partial ownership, you will need a way to determine how much to pay them as a buyout when they do so. Will it be based on their ownership percentage? A specified amount? Dependent on the company’s current capital? Will current owners be given the option to buy portions of this person’s amount as they choose?
When additional members come on board, it is typical to require that they contribute a certain amount of funds to the venture. You should specify what this requirement is and what percentage of ownership may be granted to a new member.
9. Succession Planning
Succession planning is needed to have a strategy should a member pass away. This planning will need to include details about what happens to their shares. Often, people like to appoint a successor in their will — a friend or family member they’d like to leave their portion of the business to.
You and the other members of your LLC should decide if you want any limits on who can be appointed as a successor and what rights the successor might have in the company.
There should also be a plan as to what to do with a member’s shares if they haven’t appointed a successor. Should it go to their next of kin? Be redistributed among the current members?
Once this is spelled out in the Operating Agreement, all members can update their wills to align with whatever is decided.
In your section on dissolution, the first thing you should include is how the decision to dissolve may be made. Does it require a unanimous vote? A simple majority? If there is disagreement about dissolving, can the members who wish to stay buyout those who wish to leave?
When a business dissolves, there are usually assets that need to be distributed and obligations that need to be dealt with. Your Operating Agreement should spell out how the remaining assets will be divided.
To formally dissolve a business, you must file a Certificate of Dissolution with a $70 fee with the Pennsylvania Department of State. You should make it clear who is responsible for carrying this out, as well.
11. Modifications to the Operating Agreement
Operating Agreements may need updating from time to time. As your business evolves and grows, what worked in the past may no longer work in the future. Also, there may be items initially included in your Operating Agreement that you find don’t work well for you.
Because of this potential need for change, your initial Operating Agreement should explain how changes will be made, voted on, and implemented. This includes a clear indication of who can vote on changes, how much each person’s vote counts, and what percentage of agreement is required to enact a change.
You may also wish to include who is responsible for formalizing any modifications and creating official amendments to your Operating Agreement that are legally binding.
12. Single-Member LLC Statute
Operating Agreements are important for single-member LLCs as well as multiple-member LLCs. An Operating Agreement is your way of clarifying your business’s plans and rules.
This can be useful both for your own clarity and organization but also for any third parties with whom you may seek financing or do business. It provides you additional protection by giving you a chance to put in writing which assets are tied to the business and not you.
However, you will want to specify in the Operating Agreement that you are the sole owner with 100% voting rights and the ability to make all decisions on behalf of your LLC.
13. Severability Provision
A common clause added to legal documents is a provision stating that if it turns out that one or more portions of your Operating Agreement are deemed legally invalid, it does not invalidate the rest of the agreement.
Adding this boilerplate clause protects you from possible errors in your Operating Agreement by making it so that a simple error does not invalidate the entire agreement.
Get Help Creating Your Operating Agreement
Creating an Operating Agreement is a big responsibility. You want to make sure all portions are legally valid and are worded in a way that is consistent with what you intended. ZenBusiness has resources to help make sure you don’t forget anything when creating your agreement, including a customizable template that can help get you started.
It may additionally be a good idea to seek the advice of a legal professional before you sign your document, just to make sure everything is in order.
Updating and Revising Your Pennsylvania LLC Operating Agreement
While updating (or at least considering updating) your Operating Agreement should happen regularly (such as annually), there are other times you may need to revise the agreement, as well. Any time there is a change in ownership, a new registered agent, an alteration of the management structure, etc., the agreement should be revised to ensure continued legal coverage.
Luckily, revising and updating your agreement is fairly easy to do. You can create amendments to the agreement by typing them up or revising the original document. All members should sign the new documents, and they should be kept in a safe place like before.
Keep in mind that some changes made to your business may need to be updated with the Pennsylvania Department of State. In this case, you may need to file a Certificate of Amendment and pay a $70 filing fee.
- Is an LLC Operating Agreement required in Pennsylvania?
While an Operating Agreement is not legally required in Pennsylvania, it is strongly recommended to provide additional legal protection to your business and all associated members.
- Where do I get an LLC Operating Agreement in Pennsylvania?
You can create your own Operating Agreement from scratch or download a template from any number of places online. When completed, make sure all members sign and keep your Operating Agreement in a safe place.
- Does a single-member LLC need an Operating Agreement in Pennsylvania?
Operating Agreements are good even for single-member LLCs, as they can help protect personal assets and legitimize your business to financial institutions and third-party vendors.
- Do I file an LLC Operating Agreement with Pennsylvania?
You do not need to file an Operating Agreement with Pennsylvania. Simply keep it in a safe place with your other important business documents.
- Can I write my own LLC Operating Agreement in Pennsylvania?
Yes. You are free to write the Operating Agreement yourself if you are comfortable doing so.
- Do I need a lawyer for an LLC Operating Agreement in Pennsylvania?
A lawyer is not required, but you may want to consult a legal professional when drafting your Operating Agreement just to make sure you didn’t miss anything.