What is an Operating Agreement?
An operating agreement is the governing document of a limited liability company (LLC) that outlines the ownership structure, member responsibilities, profit distribution, management authority, and procedures for the business. While not always required by state law, an operating agreement is essential for maintaining the LLC's liability protection and preventing disputes between members.
Why you need one
Without an operating agreement, your LLC is governed by your state's default LLC statute, which may not align with your intentions. More importantly, courts may "pierce the corporate veil" (remove liability protection) if an LLC lacks proper documentation, including an operating agreement. Having a written agreement demonstrates that the LLC is a legitimate business entity, not just a shell.
Key provisions for real estate
Capital contributions: How much each member contributes initially and for future expenses (repairs, vacancies, capital calls).
Profit and loss allocation: How rental income, sale proceeds, and tax benefits are distributed among members.
Management authority: Who makes decisions about property management, tenant selection, renovations, and sales. Member-managed vs manager-managed.
Transfer restrictions: Rules for selling or transferring membership interests. Right of first refusal for existing members.
Dispute resolution: Mediation or arbitration clauses to avoid expensive litigation between members.
Dissolution: How the LLC winds down, including property sale procedures and final distributions.
Single-member LLCs
Even single-member LLCs (one owner) should have an operating agreement. It documents the separation between your personal activities and the LLC's business, which is critical for maintaining liability protection. Courts are more likely to pierce the veil of a single-member LLC that lacks documentation and mixes personal and business finances.