Your California LLC Operating Agreement is a legal document establishing ground rules for 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, like the bank. 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.
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.
Technically, you don’t need an operating agreement. But no matter where you’re doing business, it’s important to have an LLC Operating Agreement:
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. Oral 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.
No. However, it may seem counter intuitive, but single-member LLCs will want 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.
No. Your LLC Operating Agreement is an internal document. It’s yours to keep on file.
No. 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.
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 can be difficult to enforce.
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.