By The Wyoming LLC Attorney TeamMay 15, 2023
An LLC's operating agreement outlines the business's internal organization and rules. Although it is not mandatory to create one in Pennsylvania, it is necessary to protect the business's limited liability status, clarify verbal agreements, and fulfill investors' and banks' requirements.
In order to start a Limited Liability Company (LLC) in Pennsylvania, the owner needs to draft a number of documents determining the business’s legal standing and organization. Filings with the state, such as your Articles of Organization and EIN, are required to get started. Other documents, like Organizational Meeting Minutes and an Operating Agreement, are not filed with the state. However, they are necessary for the LLC to be effective in limiting the owners’ liability.
Specifically, the Operating Agreement serves as the blueprint of the LLC’s internal organization by regulating its structure and rules. Without an operating agreement, your LLC will most likely not be seen as legitimate in the eyes of the court if you must go before a judge in the future.
Before you begin drafting an operating agreement, you should understand why it is necessary for your Pennsylvania business and which elements to include.
An operating agreement is a legal document outlining the structure of an LLC and the rules it abides by. Essentially, this document governs the internal operations of an LLC in a way that suits the owners. Additionally, the operating agreement serves as a binding contract in LLCs with more than one owner or member.
Unlike LLC’s articles of organization which determine the company’s status in the Department of State itself, an operating agreement only specifies the duties, rules, and regulations within the LLC. In other words, LLC members can consult the operating agreement whenever they require information on management plans, voting rights, and profit and loss allocations.
Although each LLC drafts an operating agreement according to its own needs, there are certain shared characteristics. For instance, most contain the statement of intent, the operating time period, the company’s business purpose, taxation details, and members’ financial contributions. However, it’s worth noting that the law doesn’t specify particular requirements for the operating agreement’s content, ultimately leaving the decision to the owners.
Business owners in Pennsylvania are not legally required to write an operating agreement for their LLCs. However, most LLC managing members choose to do so, as it is a highly recommended practice. Below you will find some of the reasons as to why you should create and sign a Pennsylvania LLC operating agreement.
The main benefit of an LLC is the limited liability enjoyed by the owners of the business. In other words, the member’s personal assets are treated as independent from the company’s, meaning they are protected in case of a lawsuit. That is precisely the reason many owners opt for this business structure.
However, without an operating agreement, your company’s limited liability status may be jeopardized. By detailing how your business operates, this key document gives credibility to your company and ensures the state acknowledges its legitimacy. Otherwise, your LLC status may not be recognized, especially if you operate a single-owner company. Consequently, you’d be treated as a sole proprietor and be deemed personally liable for your company’s debts and lawsuits.
When an LLC has several managing members, they have to make numerous decisions about the company’s management, structure, and operations. Initially, that’s done through verbal agreements, but they are impractical and don’t provide the necessary security.
Thus, it’s wise to put all your decisions related to the LLC’s membership interest and internal operations in writing and avoid any future misunderstandings. Additionally, the members can refer to the operating agreement whenever a conflict arises.
If you choose not to sign an LLC operating agreement, the state’s default rules for LLCs will apply automatically. These rules may not be entirely unfavorable, but they are not tailored to each company individually. As a result, some of your business’s needs will not be addressed.
In order to avoid being subject to state rules, you should draft an operating agreement. This document allows you to delve into the particulars and organize your LLC according to your needs. For instance, the governing entity may require all company profits and losses to be divided equally among members. However, if you believe that an ownership-based approach suits your business better, and all owners agree, you can implement it using the operating agreement.
During your time as a business owner, you will need to interact with investors and banks. Occasionally, they might ask you to prove you are the owner of the LLC, in which case your company’s articles of organization may not be sufficient. In that case, you will be expected to show your operating agreement. Hence, it’s advisable to have it prepared in advance instead of writing it when the need arises.
Furthermore, an operating agreement contains all information about your business that potential investors may find relevant. Rather than write new documents outlining your company’s organization and operations, let the investors examine your operating agreement.
In the event that all managing members pass away, the LLC is dissolved unless a successor is named in the operating agreement. To keep your business safe and operational, you must sign an operating agreement and include a transfer on death provision. In particular, single-owner LLCs need a named successor since they cannot operate if the only member passes away.
Legally speaking, there are no specific requirements regarding the topics covered in an operating agreement. Each LLC decides which provisions to include, depending on its particular circumstances and needs. As a result, business attorneys adopt a case-by-case approach when drafting operating agreements.
Nevertheless, there are some provisions each operating agreement should contain. The following ten are the most important ones.
Adding your LLC’s legal name to the operating agreement makes the document legally enforceable. However, the name alone will not suffice — your business’s LLC designator must also be included. In other words, your company must be labeled in the exact same way as in the articles of organization filed with the state.
The operating agreement should contain the names, addresses, and titles of each member, along with their ownership percentages. As there are no particular requirements regarding ownership, you are not expected to divide the company’s shares equally. Instead, most LLCs choose to attribute ownership according to the members’ capital contributions, which is acceptable as long as all owners are in agreement.
It’s crucial to clearly outline each member’s rights and responsibilities in the operating agreement, as this document is legally binding. As a result, if a member doesn’t perform their duties as stipulated, the court can financially penalize them. In some cases, the penalty may involve removal from the position.
Your LLC’s operating agreement should define your company’s operating procedures for profit distribution, whether you choose to share it equally among members or according to ownership and capital contributions. As long as there is a clear stipulation in the agreement, conflicts and misunderstandings can be prevented.
A crucial aspect of your business operations is making decisions, and as such, it needs to be added to the operating agreement. In particular, you need to formulate decision-making methods for various situations, including changes in management, business structure, or company rules and regulations.
If your decision-making methods involve voting, the operating agreement should denote which members have voting rights and whether all votes are counted equally. Naturally, the owners must consent to decision-making and voting rules and regulations before they can be entered into the agreement.
Regular business meetings aren’t required by law, but they provide an opportunity to discuss company issues, keep track of progress, and set business goals. Therefore, holding them periodically is advisable, particularly in situations that require voting on a certain matter.
Once you decide when and how the meetings should be held, include this provision in your operating agreement. Make sure to clearly outline who is expected to attend and whether attendance is mandatory. That way, you will have legal grounds to place the responsibility on the members who fail to fulfill their duties.
As your business evolves, changes in the ownership structure are to be expected. For instance, some of the original members could pass away, retire, or decide to embark on a different career path. On the other hand, new members may also be admitted into the structure.
To avoid complications, outline precisely how and when the ownership transfers should occur in your LLC’s operating agreement. These stipulations should include the buyout amount or percentage for the members who are leaving, as well as the contributions required of the newly admitted members. Ultimately, the exact details will depend on the arrangement all members have agreed on.
An operating agreement should contain a section on dissolution, stipulating how the decision to dissolve is made. For some LLCs, the best option is a unanimous vote, while others may consider a majority rule more appropriate.
Similarly, the operating agreement should determine how the company assets are divided, as well as how the remaining obligations are managed. It’s also important to assign a person to formally file a Certificate of Dissolution once the decision has been made, officially dissolving the LLC.
Even if certain items in the operating agreement suit your business at the time of drafting, they may hinder its performance as it evolves. Hence, it’s expected that your operating agreement will undergo changes and adjustments.
To simplify the modification process, you should include a stipulation on how the changes to your operating agreement will be made and implemented. In case you opt for voting as a decision-making method, make sure to indicate the number of votes required to enact change.
When drafting your operating agreement, you should consider adding a severability provision, a clause frequently included in legal documents to ensure that the document cannot be deemed invalid if any of its sections are unenforceable. Essentially, this clause guarantees that the agreement will not have to be rewritten in its entirety despite the potential invalidity of some provisions.
Once you have determined which sections to include in your LLC’s operating agreement, you can begin drafting it. Numerous Pennsylvania operating agreement templates can be found online, significantly speeding up the writing process for both single-member and multi-member LLCs.
However, bear in mind that creating a legal document is a big responsibility. You can attempt to do it independently, but it’s preferable to get an attorney’s help. After all, a legal expert will ensure that all provisions are correctly worded and legally valid.
In case you decide to draft the LLC operating agreement on your own, consider consulting an attorney before signing and submitting it. Let them examine the document and make necessary changes. That way, you will make certain that all your provisions are accurate and valid.
Since the operating agreement is a document guiding your LLC’s internal operations, you are not required to submit it to any governing bodies. Instead, collect all members’ signatures on the document and store it in a safe place. Consider also making a copy for each signing party. That way, if the original document is misplaced, other members will be able to provide their own copies.
For a multi-owner LLC, an operating agreement has a clear use, as it regulates the ownership percentages, rights, and responsibilities of each member. In many ways, the agreement acts as a legally binding contract between all the members that could be used in court in case of a breach.
However, in a single-owner LLC, there is only one member who has full ownership and responsibility in the company. Therefore, the sole owner may believe that an operating agreement is not necessary. Moreover, the state of Pennsylvania doesn’t require LLCs to draft operating agreements, further cementing this belief.
Nonetheless, single-owner limited liability companies can also greatly benefit from writing an operating agreement. If an LLC doesn’t have one, the state may have difficulty differentiating it from a sole proprietorship. Consequently, its limited liability status becomes jeopardized.
Additionally, single-owner LLCs are at a higher risk of dissolution due to death than multi-owner companies. Even if one of the members in a multi-owner LLC passes away, the company still has the remaining owners, allowing it to operate as usual. However, that doesn’t apply to single-owner LLCs, therefore it is crucial to name a successor. Typically, that is accomplished in an operating agreement.
Writing an operating agreement in Pennsylvania can be a challenge, especially if you have no prior experience with legal documentation. To some extent, online templates can help, but concerns about legal validity and accuracy will remain. When you purchase an LLC formation with us, we will draft your operating agreement for you. Form your Pennsylvania LLC now. Have questions? Get expert guidance from our experienced paralegals. Reach out to us through the contact form or call +1 (307) 683-0983 for assistance today.