What to Include in an LLC Operating Agreement: A Clause-by-Clause Checklist for Owners

Why does the operating agreement matter more than the articles of organization?

The articles (called a certificate of formation in Delaware) are a one-page public filing that creates the company. They say almost nothing about money or control. The operating agreement is the private contract among the members, and in most states it can override most of the statute's default rules. Delaware goes furthest: under 6 Del. C. §18-1101(c) an LLC agreement may expand, restrict or even eliminate fiduciary duties, keeping only the implied covenant of good faith and fair dealing.

That flexibility cuts both ways. A well-drafted agreement protects every owner. A one-sided one can leave a minority member with a percentage on paper, no say, no cash and no exit. The state that matters is the state of formation, not where you live or where the business operates, so check that first.

Ownership, units and the cap table

Every agreement should have a schedule listing each member, their units or percentage, and what they contributed. Make sure the numbers add up to 100 percent, match what you were promised, and say whether percentages are fixed or move with capital accounts. If ownership is tied to capital accounts, a later contribution by another member quietly shrinks you.

If there are classes of units (common and preferred, or voting and non-voting), the agreement should say exactly which rights each class has. A "Class B" interest with no votes and a subordinated place in the distribution order can be worth far less than its percentage suggests.

Capital contributions and capital calls

The agreement should state each member's initial contribution and whether anyone can ever be required to contribute more. A capital call clause should cap the total, require a stated business purpose and a vote, and give reasonable notice, usually at least 15 to 30 days.

The consequence of not paying is where the real risk sits. Options range from a simple loan by the other members, to straight dilution, to penalty dilution, to outright forfeiture. Delaware's statute expressly allows an agreement to impose penalties such as reducing or forfeiting a defaulting member's interest (6 Del. C. §18-502(c)). Our guide to capital calls and dilution works through the math.

Distributions, the waterfall and tax distributions

Profits in an LLC taxed as a partnership are taxed to the members whether or not any cash is paid out. Without a tax distribution clause, you can owe tax on income you never received, often called phantom income. A fair clause requires the company to distribute enough cash each quarter or year to cover members' estimated taxes on allocated income, at an assumed combined rate, unless doing so would breach a loan covenant.

Beyond tax distributions, look at the order of payment. Many agreements return contributed capital first, then pay a preferred return to investors, then split the rest, sometimes with a larger share (a "promote") to the managing member. Make sure you understand where you sit in that line, and whether distributions are mandatory or entirely at the manager's discretion.

Management, voting and removing a manager

Decide whether the LLC is member-managed (owners run it together) or manager-managed (one person or a board runs it). Then list the major decisions that need a higher vote: selling the company or substantially all its assets, taking on debt above a threshold, admitting new members, changing the business, related-party deals, and amending the agreement.

Minority members should look for consent rights on the decisions that could hurt them most, and for a clear way to remove a manager for cause. An agreement that lets the manager do almost anything and can only be changed with the manager's consent is a control structure, not a partnership.

Amendments: the clause that can undo every other clause

If a simple majority can amend the agreement, every protection in it is only as durable as the majority's goodwill. A fair amendment clause requires a supermajority for ordinary amendments and the consent of any member whose economic rights or obligations would be disproportionately affected. Without that, a majority could vote in a new capital call regime or a cheaper buy-sell formula after you have already invested.

Transfers, buy-sell terms and exit

Most agreements restrict transfers to outsiders and give the company or other members a right of first refusal. That is normal. What you need to check is the reverse side: when you can be forced to sell, and at what price. Triggers usually include death, disability, divorce, bankruptcy, leaving the business and removal for cause. Look for the valuation method, any discount, and whether payment comes in cash or a promissory note over several years.

If a majority holder can drag you into a sale, you should have a matching tag-along right to join any sale they make on the same terms. The buy-sell provisions guide covers pricing and funding in detail.

Vesting, leaver terms and restrictive covenants

Founders who earn their units over time should see a vesting schedule (four years with a one-year cliff is common in startups) and clear definitions of "good leaver" and "bad leaver." A bad leaver clause that lets the company buy back even vested units at cost, or at the lower of cost and fair value, can wipe out years of work over a vague definition of "cause." Ask for cause to be defined narrowly, with notice and a chance to cure.

Check also for a non-compete or non-solicit binding members. These are judged by state law, and some states treat them differently when tied to the sale of a business interest than when tied to employment. If you also work for the company, read them alongside your employment terms.

Fiduciary duties, information rights and disputes

In states that follow the Revised Uniform LLC Act, an agreement cannot eliminate the duty of loyalty, though it can narrow it if the terms are not manifestly unreasonable. Delaware allows elimination. If the agreement says managers owe "no duties other than those expressly set forth," your protection against self-dealing is only what the words say. At minimum, ask for related-party transactions to require approval by disinterested members.

You should also have the right to see the books, annual financial statements and tax information (including a timely Schedule K-1). Finally, check how disputes are resolved: mediation, mandatory arbitration, or court, and in which state. The free multi-member LLC operating agreement template in our templates library shows a balanced starting point for most of these clauses.

• Ownership table that adds to 100 percent and matches the deal.
• Capital call cap, notice period and a proportionate (not punitive) remedy.
• Mandatory tax distributions.
• Supermajority list for major decisions and a way to remove a manager.
• Amendment clause with consent for disproportionately affected members.
• Buy-sell triggers, valuation method and payment terms.
• Tag-along to match any drag-along.
• Narrow "cause" and fair bad leaver pricing for vested units.
• Information rights and a defined dispute process.

What mistakes do owners make with a do-it-yourself operating agreement?

Generic forms are a reasonable starting point, but owners tend to make the same handful of errors when they fill them in. Most of these only surface years later, during a dispute or a sale, when they are expensive to fix.

• Copying a single-member form for a company with two or more owners, so nothing covers splitting profits, votes or exits.
• Listing percentages that do not match the capital each member actually contributed, with no explanation of sweat equity.
• Leaving the buy-sell price as "to be agreed" at the time of the event, which guarantees a fight.
• Requiring unanimous consent for everything, which turns any disagreement into a deadlock.
• Never updating the agreement after a new member joins, a member leaves, or the tax election changes.
• Forgetting to have every member sign, then struggling to prove which version was agreed.

Fair version vs red flag: a quick comparison

The table below sets common risky wording against a more balanced alternative. Our Operating Agreement analyzer runs this kind of comparison from your position as a member, then lets you enter a capital call or distribution to see what the agreement does to you in dollars and percentages. Bring in a business lawyer before you sign if you are contributing significant money, giving a personal guarantee for company debt, or accepting a minority stake with no consent rights.