Resources / Glossary / Operating agreement

Operating agreement.

Aka. LLC agreement · LLC operating agreement
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What is an operating agreement?

An operating agreement is the foundational governing contract of a limited liability company (LLC). It sets out who the members are, what they own, how the company is managed, how profits and losses are allocated, how cash is distributed, and how membership interests may be transferred. For an LLC, it plays the role that the bylaws and shareholders agreement play for a corporation — rolled into one document.

Because LLC law in most U.S. states is highly flexible and largely default-permissive, the operating agreement is where almost all of the real economic and governance terms are decided. The statute supplies fallback rules, but the agreement can override most of them — making the document, not the statute, the controlling source of how the entity actually runs.

LLCs are the default vehicle for many private equity acquisition structures, joint ventures, real estate partnerships, and fund holding entities, which makes the operating agreement one of the most consequential documents in those deals.

What an operating agreement governs

The core provisions of a typical operating agreement address:

  1. Capital and ownership. Each member's capital contribution, percentage interest or units, and any capital-call obligations.
  2. Management structure. Whether the LLC is member-managed (owners run it) or manager-managed (designated managers run it), and what decisions need member consent.
  3. Allocations and distributions. How taxable income and losses are allocated, and the waterfall by which cash is actually distributed — often with preferred returns and tiers.
  4. Transfer and exit. Restrictions on transferring interests, rights of first refusal, tag- and drag-along, buy-sell mechanics, and what happens on death, default, or withdrawal.
  5. Voting and protective rights. Voting thresholds and the major decisions reserved to particular members.

Member-managed versus manager-managed

One of the first choices an operating agreement makes is the management model. In a member-managed LLC, the members themselves run day-to-day operations and generally have authority to bind the company — common in small businesses where the owners are the operators.

In a manager-managed LLC, the members appoint one or more managers (who may or may not be members) to run the business, and the non-managing members become more like passive investors. This is the standard structure for private equity and fund vehicles, where a sponsor or general partner manages while limited investors stay passive. The distinction determines who has authority to act for the company — a critical point in diligence and in any dispute over an unauthorized act.

Frequently asked.

5 questions
01 What is the difference between an operating agreement and bylaws?

An operating agreement governs an LLC, while bylaws govern a corporation. The operating agreement is broader, combining ownership economics, management, distributions, and transfer rules in one document, whereas a corporation typically splits these across its charter, bylaws, and a separate shareholders agreement.

The practical effect is similar — both are the entity's internal rulebook — but the operating agreement reflects the greater contractual flexibility that LLC law allows.

02 Is an operating agreement legally required?

In most states it is not strictly required to form an LLC, and a few states require only that it exist (not that it be filed). But operating without one means the LLC is governed entirely by the state's default statutory rules, which rarely match what the members actually intend. In practice, any LLC with more than one member or any outside capital should have a carefully drafted agreement.

03 What is the difference between member-managed and manager-managed?

In a member-managed LLC, the owners run the business and can bind the company. In a manager-managed LLC, the members appoint managers to run it while non-managing members stay passive. Private equity and fund structures almost always use manager-managed LLCs so the sponsor controls operations and investors remain passive.

04 How are distributions handled in an operating agreement?

The agreement specifies a distribution waterfall — the order in which cash flows to members. In investment vehicles this often includes a return of capital, a preferred return or hurdle, and then a split of remaining profits. Tax allocations of income and loss are addressed separately and may not track cash distributions exactly, which is a frequent source of complexity.

05 Why does the operating agreement matter so much in diligence?

Because for an LLC it is the single document that controls ownership, control, economics, and transfer rights, a buyer or investor must read it closely to understand exactly what it is acquiring and what consents a deal requires. Keeping the agreement and its amendments cross-referenced with the cap table and consent requirements queryable means those answers are available when a transaction triggers them, not buried in an amended-and-restated stack.

Related terms

Slegal governance

Survival period

How long after close a deal's representations and warranties remain enforceable — the window in which a buyer can bring an <em>indemnification claim</em>.

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Plegal governance

Protective provisions

A list of company actions that require investor consent before they can be taken — the <em>veto rights</em> that protect a minority preferred holder.

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Nlegal governance

Non-compete

A covenant barring a seller or key employee from <em>competing</em> with the business for a set time and area after a deal or departure.

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Plegal governance

Pro rata rights

An investor's right to invest in future rounds enough to <em>maintain its ownership</em> percentage and avoid dilution.

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Nlegal governance

Non-solicit

A covenant barring a seller or departing employee from <em>soliciting</em> the company's customers or employees for a set period.

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Rlegal governance

Right of first refusal

A contractual right letting a holder match a bona fide third-party offer before a shareholder may sell its stake to that outsider.

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