Understanding LLC Operating Agreements in California
Your California LLC Operating Agreement is the foundation of your LLC. It lays the ground rules for crucial issues like how your LLC will make decisions, be managed, and allocate profits. It allows your LLC to override California’s expansive default rules and may even help reinforce your LLC’s limited liability status in the event of a lawsuit. In California, it’s also the most effective document you have for proving who owns your LLC to third parties. For these reasons, among a few others, having a customized LLC Operating Agreement in your toolbox is absolutely essential in California.
When you hire us to form your California LLC, we include a free LLC Operating Agreement template you can use as a starting point. Here’s our guide to understanding California LLC Operating Agreements.
What is an Operating Agreement?
Why do I need a California Operating Agreement?
Doesn’t California law allow verbal LLC Operating Agreements?
Does a single-member LLC need an Operating Agreement?
Do I file my Operating Agreement with the CA SOS?
I’ve already filed my Articles of Organization with the CA SOS. Do I need an Operating Agreement too?
Do I need a lawyer to write my Operating Agreement?
Is my California Operating Agreement on the public record?
Should I use a free online Operating Agreement template?
An Operating Agreement is just what it sounds like: an agreement on how your LLC will operate. In the grand scheme of your California LLC’s life, it might be the most important document you sign.
But let’s break it down. An Operating Agreement is to an LLC what bylaws are to a corporation. It’s a contract between the members of your LLC spelling out the ground rules for your LLC – how your LLC makes major decisions, how membership interest is transferred, how your LLC is managed, and how you’ll dissolve your LLC when its time comes.
No one expects turbulence or disputes between members, especially when you’re just starting out. But a solid LLC Operating Agreement can help you prevent misunderstandings before they even arise.
No matter where you’re doing business, it’s important to have an LLC Operating Agreement. In California, having an Operating Agreement on file is actually required by law. But beyond fulfilling the requirements of the law, there are quite a few other reasons why you need a California Operating Agreement:
- It sets the rules. Like we said earlier, your Operating Agreement defines how your LLC will operate. What will you do if a member wants out? How will you vote to make decisions? Who gets paid what? Getting all of this down in your Operating Agreement can help you prevent misunderstandings and disputes down the road.
- It overrides default rules. In 2014, The California Revised Uniform Limited Liability Company Act vastly expanded California’s default rules. If your LLC Operating Agreement doesn’t address these default rules, your LLC will automatically be governed by them. These default rules might not be in the best interest of your company.
- It proves who owns the LLC. The California Articles of Organization do not list members. If your LLC is managed by managers, your Statement of Information may not list members, either. This means that an LLC Operating Agreement – signed by all members – is the only document you have to prove to a third party who owns the LLC. Who will need proof? Your bank, to begin with. If you want to buy land or borrow money, you’ll need your Operating Agreement for that, too.
- It can help protect your limited liability status. Limited liability is one of the most attractive qualities of the LLC structure. It protects your members from being held personally liable for business debts. But your limited liability status isn’t set in stone. To preserve it, you need to maintain a clear separation between your personal life and your business life. Letting your personal and business affairs intermingle can erode the separation between you and your LLC, leaving you vulnerable to lawsuits. An Operating Agreement doesn’t provide iron-clad protection against lawsuits, but it certainly helps. It’s one tool you have to demonstrate the legal separation between you and your business. If – heaven forbid – you end up fighting a lawsuit, you’ll want to have an Operating Agreement in your arsenal.
Yes. The California Revised Uniform Limited Liability Company Act defines an operating agreement as any agreement “oral, in record, implied, or in any combination thereof of all the members of the limited liability company.”
So technically, yes, you can hash out the rules for your LLC over carne asada burritos, shake hands, and call it an Operating Agreement. But there are plenty of reasons – most of them pretty obvious – why it’s in your best interest to get your Operating Agreement down in writing. Verbal LLC Operating Agreements are virtually impossible to enforce. An oral LLC Operating Agreement also can’t help you prove who owns your LLC or demonstrate the separation between you and your business.
In California, yes. It may seem counter intuitive, but a single-member LLC does need an LLC Operating Agreement. While you’re probably not going to have a major disagreement with yourself, there are plenty of other reasons (listed above) why your single-member LLC needs an Operating Agreement. For one, having an LLC Operating Agreement is legally required in California, even for single-member LLCs.
No. Your LLC Operating Agreement is an internal document. It’s yours to keep on file.
I’ve already filed my Articles of Organization with the CA SOS. Do I need an Operating Agreement too?
Yes. The California Articles of Organization are important – it’s the document that officially forms your LLC with the Secretary of State. But only your Operating Agreement contains the rules for how your LLC will operate.
Your LLC Operating Agreement is extremely important, so it’s not a bad idea to hire a lawyer to draw it up or, at the very least, review it.
Compared to a corporation, LLCs are extremely flexible. This is something many business owners see as a major benefit. However, when something is flexible, it can easily be bent or manipulated in ways that many business owners don’t anticipate. A lawyer can use your Operating Agreement to shape your LLC into something that works for you, while also protecting it from being warped by outside forces.
No. Though California law requires you to have an Operating Agreement for your LLC, it doesn’t require you to file it anywhere. Your California Operating Agreement is an internal document. You may need to show it to banks, lenders, or other California agencies, but your Operating Agreement won’t be posted online or entered into the public record.
However, plenty of other documents you file will become part of the public record, like your Articles of Organization and your Statement of Information. This means that your business address will be posted on the California Secretary of State’s website, exposing your privacy. We value privacy, so we came up with a solution: we’ll let you use our California business address when you hire us.
Probably not? We can’t vouch for the sea of free LLC Operating Agreement templates available online. What we do know is that your LLC Operating Agreement is crucially important to your business, so at the very least, yours should be somewhat customized. When you hire us to form your California LLC, we provide a customizable Operating Agreement template that can help you get started.
What you include in your California Operating Agreement will depend on how you want to run your LLC. It’s not unheard of for an Operating Agreement to span 20 pages or more, but it doesn’t have to.
In 2014, California passed the Revised Uniform Limited Liability Company Act (RULLCA). This act greatly expanded California’s so-called “default rules.” If your Operating Agreement is silent on certain issues, your LLC will be governed by California’s default provisions. We’re not lawyers, so we can’t speak with authority on the implications of each default provision. However, we’ve highlighted a handful that we think are important to address in your Operating Agreement.
At the minimum, your California LLC Operating Agreement should cover the following:
Most LLC Operating Agreements open by recording basic information about your LLC, like its name, purpose, business address, California registered agent information, and the names of all members. This section might also include the effective date of the Operating Agreement and a list of terms and definitions used in the document.
Unless your LLC is a single-member LLC, you’ll need to outline how ownership is divided among members. LLC ownership – called membership interest – is usually represented by a percentage. Membership interest is often determined by how much capital a member contributes to the LLC, but it doesn’t have to be. Membership interest is important because it usually determines how profit and voting power is distributed.
Under RULLCA, California LLCs are automatically member-managed. If you’d like your LLC to be manager-managed, you have to specify this in both your Articles of Organization and your Operating Agreement.
Will your LLC make major decisions – like whether to allow a transfer of membership interest or dissolve your company – by vote? If so, you’ll need to set the rules.
Will each vote have equal power, or will voting power be determined by membership interest? Does every member have voting rights? Are there some issues that require a unanimous vote to decide?
If your Operating Agreement doesn’t define your voting process and rules, your LLC will be governed by California’s default provisions. Under RULLCA, voting power depends on membership interest and amending Articles of Organization or the Operating Agreement requires a unanimous vote. Other issues are automatically decided by a simple majority vote.
This means that under the default provision, a member with only a small membership interest – even just 1%! – has the power to veto amendments to your Operating Agreement or Articles of Organization, even if an overwhelming majority disagrees.
This is where you’ll agree on how much money (or other assets, including property or services) each member will contribute. This usually determines membership interest. It’s important to get this part down in writing because if you don’t specify these contributions in your Operating Agreement, members are not legally obligated to contribute anything (even if they said they would).
How will profits and losses be distributed to members? As we all know, disputes over money can be long and bitter. This is one of the few issues that RULLCA doesn’t provide a default provision for, so it’s vital to clearly spell out how profits will be allocated.
This is where you need to think ahead a little. Things change, and even close-knit business partners sometimes need to part ways. What will you do if one of your members goes bankrupt, becomes incarcerated, or – heaven forbid – dies?
If your Operating Agreement doesn’t address membership changes and transfers, a member can transfer their membership to any person or entity, without approval from the remaining members. This means that your LLC could someday be controlled by members you never approved.
If you want some say over how membership is transferred, it’s important to specify your arrangement in your Operating Agreement. For example, an Operating Agreement might specify that membership transfers be decided by a unanimous or simple majority vote.
Here, you’ll outline the steps needed to dissolve or “wind down” your California LLC. Usually, winding down requires a unanimous vote, but you can specify a different procedure in your Operating Agreement if you wish. Before you can close your LLC, you’ll have to pay debts, distribute assets, and file the right dissolution paperwork with the California Secretary of State.
Lastly, make sure all members sign your Operating Agreement. Without the signature of each member, the Operating Agreement is virtually impossible to enforce.
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Unless you’ve been to law school and aced your contract writing class, writing an Operating Agreement from scratch probably seems next to impossible. When you hire us to form your LLC, we’ll provide a free Operating Agreement template to get you started.