Operating agreement: how founders lock in roles, ownership, and decision rights

An operating agreement is the internal document that sets the rules for how a limited liability company functions. While the articles of organization or articles of incorporation are filed with the Secretary of State to formally create the business entity, the operating agreement stays private.

This legal document is central to liability protection. Without it, the LLC may fall back on the state’s default rules, which rarely match the specific needs of a startup or small business. By spelling out ownership percentages, management structure, and the rights and duties of each member, the agreement prevents uncertainty about how day-to-day and long-term decisions will be made.

Unlike bylaws, which are used in corporations, or verbal agreements, which often fail to hold up in disputes, an LLC operating agreement provides a written framework for ownership interest and internal operations.

Why startups and small businesses need an operating agreement

An operating agreement gives business owners a written framework that separates personal assets from company obligations. 

Beyond protection, the agreement reduces conflict. By spelling out ownership interest, voting rights, and decision-making processes, founders avoid disputes over who controls day-to-day operations or how profits will be shared.

Lenders and investors also look for evidence of structure. An LLC operating agreement signals that the company has clear internal governance, which makes it more credible than a sole proprietorship or an informal verbal arrangement. This legitimacy can make a difference when negotiating with outside parties or pitching a business plan.

Even single-member LLCs benefit from having an agreement in place. Banks often request it when opening accounts, and it provides a simple way to document the company’s business purpose and operations for compliance. For small businesses planning to scale, starting with the right paperwork prevents costly delays later.

Key provisions to include in an LLC operating agreement

Not every operating agreement looks the same. The details depend on your business structure, number of members, and long-term plans. Still, most LLC agreements include certain provisions that protect members’ ownership and clarify how the company will run.

1 - Ownership and contributions should be clearly documented

• Define ownership percentages and how they are calculated.

• Record members’ ownership based on initial contributions of cash, property, or services.

• Establish rules for admitting new members and valuing their membership interest.

2 - The management and decision-making structure must be defined

• Decide between a member-managed LLC or a manager-managed LLC.

• Specify how day-to-day decisions are made versus major shifts in the business purpose.

• Clarify which actions require a unanimous vote versus a simple majority.

3 - Profit distribution and tax considerations also need to be addressed

• Explain how profits and losses are divided among members.

• Address pass-through taxation and related reporting obligations.

• Include buyout provisions for exits or ownership transfers.

4 - Operational details should not be overlooked

• Document the LLC’s principal office, registered agent, and lawful business purpose.

• Set standards for recordkeeping and internal operations.

• Add dispute resolution provisions to avoid costly litigation.

State law and operating agreements

An LLC operating agreement does more than align members; it prevents your startup from being subject to rigid state default rules that may not match your business needs. When no agreement exists or it’s silent on an issue, state law fills the gap.

Under California’s Revised Uniform Limited Liability Company Act (RULLCA), § 17704.07, a member-managed LLC has default rules that members have equal voting rights, manage the business, and decide ordinary matters by majority vote. 

Acts outside the ordinary course (like selling substantial company assets or merging) require unanimous member consent, unless the operating agreement says otherwise.

Also in California, unless otherwise specified in the operating agreement, amendments to the operating agreement require unanimous consent.

In New York, statute LLC Law § 417 requires members of an LLC to adopt a written operating agreement that addresses the business of the LLC, the conduct of its affairs, and the rights, powers, limitations, or responsibilities of members or managers.

New York default rules also make it so that, if the operating agreement is silent, amendments that affect contributions, distributions, or the computation of member distributions often require the written consent of each member adversely affected by the change. The operating agreement may eliminate or limit certain liabilities of managers, but cannot do so for acts in bad faith, intentional misconduct, or knowing violations of law.

That’s why every LLC should customize its operating agreement to cover key default areas rather than rely on “generic” or “template” versions. If you leave certain items blank, you may end up bound by statutes that require unanimous votes or impose equal rights even when you’d prefer a different arrangement.

Operating agreements by ownership structure

Operating agreements serve different purposes depending on how many people own the company. The needs of a single-member LLC look different from those of a multi-member LLC, but both benefit from having clear rules in writing.

Single-member LLCs

It’s a common misconception that single-member LLCs don’t need an operating agreement. In reality, having one strengthens liability protection by showing a clear separation between business assets and personal assets.

Banks and lenders often require a written LLC agreement when opening a business account or applying for financing. Without it, the company can appear incomplete, which may delay approvals or limit access to credit. For startups planning to raise outside capital, the document signals that governance is already established.

A single-member operating agreement also creates a written record of the business purpose, initial contributions, and internal operations. Even if you are the only member, this record supports compliance and simplifies tax filings.

Multi-member LLCs

When more than one person owns an LLC, the operating agreement becomes even more critical. A multi-member LLC must balance members’ ownership percentages with clear rules for contributions, voting rights, and profit distribution. Without this clarity, disagreements over money or authority can slow down decision-making and harm the business.

Startups especially benefit from documenting how capital contributions are made and how membership interest is valued. These terms reduce friction when new members join or when an existing owner adjusts their stake.

For investors, a well-drafted LLC agreement signals stability. It shows that the management structure and decision-making processes are in place, and that internal operations won’t be derailed by personal conflicts. This credibility can be the difference between securing funding and being passed over in favor of a competitor with stronger governance.

Key differences at a glance

Practical steps to create an operating agreement

Drafting an LLC operating agreement is about making sure key details are documented and future changes are anticipated. Here are the major steps founders should follow:

1. Define ownership and rights clearly

• Capture how ownership interest is divided among members.

• Spell out how voting rights are exercised and how profit distribution will work over time.

2. Plan for future changes

• Decide how new members will be admitted and how their membership interests will be valued.

• Include buyout terms for when an owner exits or transfers ownership interest.

3. Review with a legal professional

• Because state law differs, have your draft reviewed by counsel.

• Confirm it aligns with the articles of organization and reflects the lawful business purpose of the company.

4. Keep the agreement updated

• Update the document as the business grows and circumstances change.

• Adjust for new capital contributions, changes in management structure, or evolving tax considerations.

• Use related documents, like business formation documents, to keep internal operations consistent across filings.

Operating agreements vs other business structures

An LLC operating agreement is distinct from the documents used in other business entities. Sole proprietorships, for example, have no internal document to separate business and personal liability. That lack of structure can leave business owners personally responsible for debts and obligations.

Corporations rely on bylaws and shareholder agreements instead of an LLC agreement. Bylaws outline how directors are elected, how officers manage day-to-day operations, and how corporate formalities are observed. While similar in purpose, they differ in scope and are tied to the corporate model rather than LLC formation.

Comparing LLCs with other types of LLCs or corporate structures is also important for tax considerations. For example, some founders weigh whether to keep the LLC or elect treatment as an S corporation. Understanding these differences helps startups choose the right business structure and draft documents that match their long-term business plan.

From legal setup to financial setup with Rho

Forming an LLC and drafting an operating agreement are important first steps, but they are only part of building a durable business. Strong financial systems give those legal foundations real power.

At Rho, we help startups and small businesses simplify banking, capital management, and internal operations so they can focus on growth. By pairing clear governance with strong financial tools, founders can move forward with confidence, knowing both the legal and financial building blocks are in place.

Get started with Rho.

FAQs

Is an operating agreement legally required?

Most states do not require LLCs to file an operating agreement with the secretary of state, but many recommend having one. Even where not mandatory, it is a legally binding contract that strengthens liability protection and defines how the company operates.

What happens if my LLC does not have an operating agreement?

Without one, your company defaults to the state’s default rules. These may require a unanimous vote for certain decisions or impose ownership and profit distribution terms that don’t fit your business plan. This lack of control can create problems for startups and small businesses.

Do single-member LLCs need operating agreements?

Yes. A single-member LLC benefits from having a written agreement that separates personal assets from business assets, outlines initial contributions, and provides documentation for banks and lenders.

Can I write my own operating agreement or should I hire a lawyer?

Business owners can use an operating agreement template as a starting point, but it’s best to have a legal professional review it. State law varies, and a lawyer can make sure your document meets specific needs and complies with local requirements.

What’s the difference between an operating agreement and articles of organization?

The articles of organization are filed with the Secretary of State to legally form the LLC. The operating agreement is an internal document that governs management structure, decision-making processes, and profit distribution among LLC owners. Both are essential to LLC formation.

Can operating agreements be amended later?

Yes. LLC owners can update their agreement as the company grows, whether to add new members, adjust ownership percentages, or change management structure. Amendments should be documented in writing to remain legally binding.