The Operating Agreement: What LLC Owners Get Wrong Before Anything Goes Wrong
Most LLCs get formed with a boilerplate operating agreement nobody reads. That document governs what happens when partners disagree, someone wants out, or the business faces a crisis.
An LLC is easy to form. File the articles of organization with your state, pay the filing fee, and the legal entity exists. The part most founders skip, or complete with a free template they don’t fully read, is the operating agreement. That’s the document that actually governs how the business works, and it matters most exactly when the business is under the most stress.
Here’s what tends to go wrong.
The default rules weren’t designed for your business
Every state has default LLC rules that apply when an operating agreement doesn’t address a situation. These defaults were written to cover a broad range of businesses and they’re not tailored to yours. In many states, for example, the default rule is that profits and losses are split equally among members regardless of how much each person invested or contributes to operations.
If you have two partners who each own 50% of the equity but one put in three times the capital, the default rule creates a result neither of you probably intended. The operating agreement is where you override the defaults and write down the actual deal.
Voting rights and decision authority need to be explicit
Who decides what? This sounds obvious until a real decision needs to be made and two partners have different memories of what they agreed to. Routine operational decisions, major financial commitments, adding new members, changing the business direction: each of these can have different authorization thresholds, and if the operating agreement doesn’t specify them, you’re relying on memory and goodwill.
A well-drafted operating agreement defines which decisions require unanimous consent, which require a simple majority, and which a managing member can make unilaterally. It also defines what counts as a “major” decision. Ambiguity on this point is the source of a disproportionate share of LLC disputes.
The buy-sell provision is the one you’ll be glad you have
A buy-sell agreement (sometimes called a buyout clause or transfer restriction) governs what happens when a member wants to leave the LLC, dies, becomes disabled, or is forced out. Without one, you’re in uncharted territory at the worst possible time.
The key questions a buy-sell provision answers: Can a member sell their interest to a third party, or do the other members have right of first refusal? How is the business valued when a buyout is triggered? What happens to a member’s interest if they die and their estate becomes the inheritor?
These aren’t hypothetical edge cases. People leave businesses, get divorced, or die. A clearly written buyout provision doesn’t prevent those events from being painful. It does prevent them from also being catastrophic for the business itself.
Sweat equity and capital contributions should both be documented
Many LLC disputes start with a disagreement about what each party contributed at the beginning. One member put in cash; another put in intellectual property, client relationships, or just a lot of unpaid time. Both types of contribution are real. Neither is automatically valued correctly if the terms aren’t written down.
An operating agreement that distinguishes between capital contributions and service contributions, assigns percentage interests explicitly, and documents any special rights that come with specific contributions (preferred distributions, management authority) is much less likely to generate disputes than a one-line statement saying “the members own the company equally.”
Deadlock resolution and dissolution need a path
Two partners who each own 50% and disagree on a major decision are deadlocked. Without a resolution mechanism in the operating agreement, that deadlock can paralyze a business indefinitely or end up in court, where the outcome is expensive and unpredictable.
A well-drafted agreement gives deadlock somewhere to go. Common mechanisms include a designated tiebreaker (a third party or neutral board member with authority to resolve specific categories of dispute), a buy-sell trigger that allows one partner to offer to buy the other out at a stated price, or a mediation requirement before litigation.
The same logic applies to dissolution. If the business fails or the partners simply want to wind it down, how does that happen? Who decides? How are remaining assets distributed? These questions are much easier to answer in advance than in the middle of a conflict.
A good operating agreement doesn’t mean you’re expecting the business to fail or the partnership to dissolve. It means you’ve had an honest conversation about how decisions get made, what each person’s contribution is worth, and what happens in the situations nobody wants to think about. That conversation, done carefully and documented well, is one of the most useful things you can do for a new business.
Most of the provisions that matter most are never triggered. But the ones that are tend to matter a great deal.