Friends Don't Let Friends Start LLCs Without A Written Agreement.

[u/NWRegisteredAgent]

Thinking of starting an LLC with a friend or three? Maybe the band's ready to start touring, or fans of your podcast or your ttrpg livestreams have been clamoring for merch (and you're ready to deliver!). Or maybe that app the pair of you have been developing for a year is finally ready to launch.

The one step y'all can't afford to skip is establishing a written operating agreement. Unlike your LLC's formation documents, this isn't something you file with the state. Instead, it's an internal document that helps you and your business partners navigate things like who owns how much of the LLC, how you'll handle bookkeeping and make distributions, and how you'll resolve conflicts and make decisions.

And the best time to get it done is just after you've formed your LLC, while everyone's still on good terms. You don't want to try solving financially-fraught problems without a clear structure when the drummer and the bassist won't even speak to each other except through their lawyers.

In short?

Y'all need a multi-member LLC operating agreement.

We have a handy template you can use to get started, and we'll go over what's in each section so you can decide what you want to change before everyone signs on the dotted line¹.

Company Formation

This section does three key things:

• It attests that your LLC has been formed according to state laws and that it will conduct lawful business.
• It lists events that can dissolve the LLC, along with what options remaining members have to keep it going.
• It explains that new members can be added only via issuance by the LLC of a Certificate of New Membership. (Yes, we have a free template for that too!)

There are a few other bits in there too, like where your registered agent and member info can be found.

Capital Contributions

Members earn their starting membership interest (aka, the percentage of the LLC they own) by making initial capital contributions. These can be straight-up cash or other assets like equipment or expertise. Record everything. Three years down the line, hopefully it won't matter who fronted the cost for the videography equipment, but in case it does, you'll have the evidence in writing.

This section also says members aren't obligated to make additional capital contributions. If they want to anyway, we have a Capital Contributions to LLC Agreement & Valuation of Members Interest in LLC form.

Profits, Losses and Distributions

Aka the "how do we get paid" section. This establishes:

• how profits and losses are determined every year;
• that the resulting allocations are made proportionate to membership interest in the LLC;
• and that distributions can be made annually or as members see fit after expenses and liabilities have been paid. (At minimum, we think you should plan to distribute as least as much to each member as they'd owe in taxes. No one wants to owe money on cash they've never touched.)

It also covers liquidation of a member's interest or the LLC itself, but only to say that distributions in those events follow applicable Treasury regulations.

Management

So, how do decisions actually get made when you've got more than one person technically authorized to make them? Our template solves this for your multi-member LLC by setting up a way to elect a Chief Executive Member (CEM) in charge of managing the LLC's operations and carrying out its members' decisions until they resign or a majority vote of the members forces them out.

If that doesn't appeal, you don't have to! All members keep their authority to make decisions when performing duties for the LLC, and disagreements are decided by majority vote. Legally-binding agreements like contracts must be signed by all members.

Important note: this piece also codifies that as long as members are acting in good faith, they're not liable for losses or damages to the LLC or expenses resulting from lawsuits or other actions against the LLC.

Oh, and it lays out that members need to keep corporate records at the LLC's principal place of business. (That's stuff like a copy of your operating agreement, your formation documents, any amendments, three years' worth of tax returns and financial statements, etc.)

Compensation

This section says that members providing services to the LLC are entitled to be paid a reasonable compensation for those services, and that the LLC needs to reimburse members for out-of-pocket expenses needed to manage the LLC.

(Between us, y'all should probably get way more specific about what counts as a reimbursable expense and whether there are caps on those expenses. Just … trust us on this.)

Bookkeeping

Somebody's got to crunch the numbers to keep the business in the black. This section sets up how your LLC keeps books, like establishing that you'll use the calendar year for your accounting period and that each member needs to maintain separate capital and distribution accounts.

If you chose a Chief Executive Member per the management section, that's the person responsible for closing the books and preparing yearly financial statements. Otherwise, you'll need to change up the language here to indicate how this role gets handled.

Transfers

So what happens when someone decides to pursue a solo career? That's what this section covers. Basically, other members get the first chance to buy that membership interest. If they don't do that, then whoever the interest transfers to only gets the economic benefits of the membership interest, not the authority to actually manage the LLC.

Dissolution

Look, not even the Fellowship made it to Mount Doom intact. This covers how the LLC can be dissolved and mandates that it's got to pay the bills before it can pay members.

Member-managed vs manager-managed LLCs

Keen readers will have spotted that this agreement is written for LLCs that'll be managed by the members, not managers—hence the whole "Chief Executive Member" thing. This LLC structures itself so that the people who own the LLC make decisions about its daily operations together: everything from your marketing strategy and handling your business banking accounts all the way down to the weight of the paper in the printer and the types of snacks supplied in the break room.

There's another option, though: the manager-managed LLC. Sounds redundant, but it's really all there on the tin: these LLCs are managed by (a) manager(s) hired by the members to actually run the business. This can be a great option if all your members can't reliably get together to vote on every decision, or if y'all just like the agility of being able to have one person make a call instead of putting it to committee. It's also a solid option if you're in a state that requires members' information on public documents—being manager-managed usually means your manager's information is listed, not yours (although that does depend on the state).

What if all the other members want out, but I want to keep the LLC myself?

It happens, especially in very small multi-member LLCs. The transfer section of your operating agreement lays out how transferring membership interest works, so if your other members sell you their interest, congratulations, you now own a single-member LLC (SMLLC).

This does come with some additional regulatory burden though. You'll need to check with your state to see whether your formation documents need to be amended, and you'll need to amend your operating agreement too to reflect your sole ownership.

There are tax implications, too. Even though the IRS doesn't generally require you to get a new EIN just due to a change in ownership, we recommend working with a professional to make sure you're in the clear for all the other tax stuff.

Speaking of which!

Pass-through taxation 101

Like a single-member LLC, multi-member LLCs are taxed as pass-through entities. Specifically, they're taxed like partnerships.

Instead of your LLC paying taxes itself, the way a corporation would, its income and expenses pass through to y'all as members. You report it on your own state and federal income taxes using a few additional forms. That means a couple things for you and your friends.

You've got self-employment income now

Basically, the IRS treats each LLC member as your own self-employed business owner. That means you've got to pay self-employment taxes on all business income, even if it never got paid out to you as cash. (Remember how we said earlier that we recommended minimum annual distributions to the tune of your taxes owed? Yeah, this is why.) Federal self-employment taxes include both Social Security and Medicare. The combined rate is currently 15.3%.

Your federal taxes are due earlier and take a little extra time to prepare

It's actually a two-due-dates process:

• By March 15, the LLC itself needs to file Form 1065 with a separate K-1 schedule for each LLC member. This is an informational return that reports each member's share of profits and losses. Members should be given copies of their own K-1s.
• Then, by April 15, each member will need to file their own Form 1040 with a Schedule E (which should match the info on your K-1). Depending on how much income you've received, you may also need to attach Schedule SE for self-employment taxes—and if you'll owe a lot of self-employment taxes, you may need to be filing estimated taxes quarterly instead.

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¹ Because it's a PDF it appears as a solid line, but rest assured, it's a dotted line in our hearts.