Forming a limited liability company involves more than filing documents with the state. An LLC operating agreement establishes the internal rules for how the company will be owned, managed, and operated.
A well-drafted agreement can clarify the owners’ expectations before a disagreement, ownership change, or unexpected event occurs. Although every company is different, Colorado business owners should understand the major decisions an operating agreement may need to address.
What Is an LLC Operating Agreement?
An operating agreement is an internal document governing the relationship among an LLC, its members, and its managers.
Unlike the articles of organization used to create an LLC, the operating agreement generally is not filed with the Colorado Secretary of State. It is maintained with the company’s important records.
Colorado law gives LLC owners considerable flexibility to establish their own rules. However, that flexibility is not unlimited, and an operating agreement cannot override every requirement imposed by law.
An attorney assisting with business formation can help owners create an agreement that reflects the company’s actual ownership, management structure, and long-term plans.
Ownership Interests and Initial Contributions
An operating agreement should clearly identify the LLC’s members and explain what each owner is contributing to the business.
Contributions may include:
- Cash
- Equipment or other property
- Intellectual property
- Services
- Industry experience
- Existing business assets
The agreement should also state the ownership interest each member receives. Those percentages may affect voting power, allocations, distributions, and the amount each owner receives if the company is sold or dissolved.
Ownership does not always need to correspond directly to the amount of money contributed. If the owners intend to use a different arrangement, the agreement should explain it clearly and be coordinated with appropriate tax advice.
How Will the LLC Be Managed?
An operating agreement should establish whether the LLC will be member-managed or manager-managed.
In a member-managed LLC, the owners generally participate directly in operating the company. In a manager-managed LLC, management authority is delegated to one or more designated managers, who may or may not also be members.
The agreement may address:
- Who can enter contracts on behalf of the company
- Who can open or access business accounts
- Who may hire employees or independent contractors
- Who oversees daily operations
- Whether a manager’s authority is limited
- Which decisions require approval from the members
- How a manager may be appointed, removed, or replaced
Clearly defining authority can reduce confusion and help prevent one owner or manager from making commitments that the other owners did not expect.
Voting Rights and Important Decisions
Not every business decision requires a formal vote. However, the operating agreement should identify which decisions can be made through ordinary management and which require member approval.
The agreement may establish voting procedures for decisions such as:
- Admitting a new member
- Borrowing a substantial amount of money
- Purchasing or selling major assets
- Changing the nature of the business
- Entering a significant contract
- Amending the operating agreement
- Merging with or acquiring another company
- Selling or dissolving the business
Voting rights may be based on ownership percentages, divided equally among members, or structured another way.
The agreement should also establish the level of approval required. Routine matters might require a simple majority, while major transactions could require a supermajority or unanimous consent.
What Happens If the Owners Are Deadlocked?
An LLC with two equal owners can encounter a serious problem if the owners disagree and neither has enough voting power to make a decision.
Rather than waiting for a conflict to occur, the operating agreement can establish a deadlock-resolution process. Depending on the company, that process might involve:
- A meeting between the owners
- Mediation
- Input from an agreed-upon advisor
- Arbitration
- A buyout procedure
- A process for selling or dissolving the company
No single method is appropriate for every business. The goal is to establish a workable process before the owners’ relationship is under strain.
Profits, Losses, and Distributions
The operating agreement should explain how the company’s profits and losses will be allocated and how distributions may be made to the members.
Questions to consider include:
- Will distributions follow ownership percentages?
- When may the company make distributions?
- Who determines whether the business has enough cash to make a distribution?
- Will the company make distributions intended to help members address tax obligations?
- Will members receive salaries, guaranteed payments, or other compensation?
- How will business expenses paid personally by a member be reimbursed?
These provisions should be coordinated with the LLC’s tax classification and advice from a qualified tax professional. An arrangement that appears straightforward from a business perspective may have consequences for the company and its owners.
Adding New Owners
A growing business may eventually bring in another owner. The operating agreement should establish how new members can be admitted and what approval is required.
It may also address:
- How a new ownership interest will be valued
- What the new member must contribute
- Whether existing members have an opportunity to purchase the interest first
- Whether the new member receives voting rights
- Whether the new member must sign the existing operating agreement
- How the addition affects the current owners’ percentages
Without a defined process, adding a new owner can create uncertainty about authority, compensation, and control.
Restrictions on Transferring Ownership
An LLC owner may eventually want—or need—to transfer an ownership interest. The other owners may not want that interest transferred freely to an outside person.
An operating agreement can place reasonable restrictions on transfers and explain what happens if a member wants to sell, give away, or otherwise transfer an interest.
Transfer provisions may include:
- A right of first refusal for the other members
- Approval requirements for an outside buyer
- Restrictions on transfers to competitors
- Rules for transfers to a trust or family member
- A distinction between receiving economic benefits and becoming a voting member
- A method for valuing the interest
These rules can help the remaining owners maintain control over who becomes involved with the company.
Death, Incapacity, Divorce, or Bankruptcy of an Owner
An operating agreement should also prepare for events the owners may not expect.
Important questions include:
- What happens to an owner’s interest after death?
- May a surviving spouse or beneficiary become a voting member?
- Will the company or remaining owners purchase the interest?
- Who exercises an owner’s rights during incapacity?
- What happens if an ownership interest is affected by divorce?
- How will the company respond if a member files for bankruptcy?
- How will the ownership interest be valued?
These provisions should be coordinated with each owner’s estate plan. For example, an operating agreement, buy-sell agreement, trust, and beneficiary plan should not give conflicting instructions about the same business interest.
Business Succession and Buyout Terms
For many owners, the LLC is both a source of income and a significant personal asset. The operating agreement should support the owners’ broader plans for the future of the business.
A buyout or succession provision may address:
- Events that trigger a purchase
- Whether a purchase is required or optional
- Who may purchase the interest
- How the purchase price will be calculated
- Whether an appraisal is required
- How often a stated business value should be updated
- Whether payment may be made over time
- How the purchase will be funded
These decisions are closely related to business succession planning. Addressing them in advance can help prevent a family member from unexpectedly inheriting an interest that the remaining owners cannot manage or afford to purchase.
Records, Meetings, and Member Information
The agreement can establish practical procedures for maintaining company records and keeping members informed.
It may identify:
- The records the LLC will maintain
- Where records will be stored
- Who may inspect financial information
- How often financial reports will be provided
- Whether annual meetings will be held
- How meetings may be called
- Whether members can participate remotely
- How written consents and business decisions will be documented
Consistent recordkeeping can help the owners understand the company’s financial position and document that important decisions were properly authorized.
Withdrawal, Removal, and Dissolution
The operating agreement should explain whether a member may voluntarily leave the LLC and what happens if an owner stops participating in the business.
Depending on the owners’ goals, it may also address whether a member can be removed for circumstances such as fraud, misconduct, loss of a required professional license, or a material breach of the agreement.
The agreement should identify events that may result in dissolution and establish procedures for:
- Winding down operations
- Paying company obligations
- Selling or distributing company property
- Resolving remaining contracts
- Distributing any remaining value among the members
Clear procedures can make an already difficult business transition more manageable.
Does a Single-Member LLC Need an Operating Agreement?
An operating agreement can still be valuable when an LLC has only one owner.
For a single-member LLC, the agreement may:
- Document the owner’s authority
- Explain how the company will be managed
- Support the separation of business and personal affairs
- Identify a successor manager
- Establish procedures for incapacity
- Coordinate the business interest with the owner’s estate plan
- Provide information requested by banks, lenders, or other parties
The agreement may become even more important if the company later adds an owner. A document designed for a single-member company should be reviewed before that change takes place.
When Should an Operating Agreement Be Reviewed?
An operating agreement should reflect how the company actually operates. It may need to be reviewed when the business:
- Adds or loses an owner
- Changes its management structure
- Takes on significant financing
- Opens another location
- Introduces a new line of business
- Experiences substantial growth
- Changes its tax classification
- Acquires or sells important assets
- Adopts a business succession plan
The owners should also review the agreement after major personal events, including marriage, divorce, incapacity, or the death of a member.
Create an Agreement That Fits the Business
An LLC operating agreement should do more than confirm who owns the company. It should establish practical rules for management, voting, distributions, ownership changes, disputes, and unexpected events.
Using a generic form may leave important questions unanswered or create provisions that do not match the company’s actual operations. A customized agreement can help the owners understand their rights and responsibilities while supporting the long-term stability of the business.
Mason Law & Planning Group helps Colorado business owners form LLCs, prepare operating agreements, and coordinate business interests with succession and estate plans. To discuss an existing or proposed LLC, contact Mason Law & Planning Group.