12 Clauses Every LLC Operating Agreement Should Include
For LLCs with $5–50 million in enterprise value, the operating agreement is not a formality. It is the backbone of the business relationship among members. It sets the rules for ownership, control, profit distributions, exits, and dispute resolution. When it is vague or incomplete, even a healthy company can quickly find itself in conflict, deadlock, or litigation.
From the members' perspective, a well‑drafted operating agreement does three key things:
It protects your capital and economic rights, clarifies how decisions are made and who controls what, and provides clear paths for change such as growth, new members, and eventual exits.
Below, we outline 12 critical sections every LLC operating agreement should address, with a focus on closely-held and mid‑market corporate clients with member‑level concerns.
Formation, Purpose, and Term of the LLC
Capital Contributions and Capital Calls
Ownership Interests, Classes of Units, and Economic Rights
Management Structure and Authority (Member‑Managed vs. Manager‑Managed)
Voting Rights, Quorum, and Deadlock Provisions
Profit and Loss Allocations; Distributions and Tax Matters
Transfer Restrictions, Buy‑Sell Rights, and Exit Provisions
Admission of New Members and Issuance of Additional Equity
Member Duties, Non‑Compete, and Confidentiality Obligations
Information Rights, Reporting, and Inspection
Dispute Resolution, Indemnification, and Limitation of Liability
Dissolution, Liquidation, and Wind‑Up
Putting It All Together
Formation, Purpose, and Term of the LLC
Every operating agreement begins with the basics: how the LLC was formed, why it exists, and how long it will last. These provisions may look simple, but they set the foundation for everything that follows. The agreement should identify the state of formation, reference the filing of articles or charter documents, and confirm the effective date.
Equally important is the statement of business purpose. Some LLCs choose a narrow purpose, such as “to own and operate a specific facility.” Others adopt a broad purpose, such as “to engage in any lawful business activity.” A broad purpose gives management flexibility to pursue new opportunities without constantly amending the agreement, while a narrow purpose can provide clarity and focus if the venture is tightly defined.
Finally, the agreement should specify the term of the LLC. Many companies are perpetual by default, but some ventures benefit from a defined term, especially when tied to a project or investment cycle. A clear dissolution framework ensures members understand when and how their capital will be returned if the business winds down.
From the members’ perspective:
A broad business purpose gives management flexibility to pursue new opportunities.
A clearly defined term and dissolution framework provides certainty about capital return.
Aligning the business purpose with growth strategy and regulatory requirements ensures adaptability and compliance.
Capital Contributions and Capital Calls
Capitalization terms are among the most critical provisions in the operating agreement. This section defines how the company is funded initially, whether members may be asked to contribute more capital later, and what happens if someone cannot or will not participate in a capital call.
The agreement should first specify the nature of initial contributions—whether cash, property, intellectual property, or services—and how those contributions are valued. It should then address whether additional contributions are mandatory or discretionary. Capital call mechanics, including notice requirements, timing, and approval thresholds, must be spelled out clearly to avoid disputes.
Finally, the agreement should outline the consequences of failing to fund a capital call, which may include dilution of ownership, loans from other members, or loss of certain rights.
From the members’ perspective:
Clarify whether your contribution is a one‑time investment or if you could be required to invest more.
Understand what happens if you cannot or choose not to participate in a capital call.
Know whether majority members can effectively force you to contribute or dilute your interest.
Practical protections for members:
Require supermajority approval for capital calls to prevent abuse by controlling members.
Spell out default remedies in detail, such as dilution formulas or loan conversion terms, to avoid costly disputes later.
Ownership Interests, Classes of Units, and Economic Rights
The operating agreement should clearly define the equity structure of the LLC. This includes the types of membership interests that may be issued, how ownership is measured, and the rights attached to each class. Some LLCs use simple percentage interests, while others adopt unit‑based structures that allow for preferred units, non‑voting units, or profits interests. The agreement should also spell out economic rights such as distributions, priority returns, and liquidation preferences, along with the voting rights tied to each class of units.
From the members’ perspective:
Your equity stake is more than just a percentage number.
You need to know whether preferred classes receive distributions before you.
Understand if waterfall provisions affect how sale or liquidation proceeds are shared.
Confirm whether your ownership translates into proportionate voting power or if you are in a non‑voting class.
Tip for LLCs issuing incentive units:
Profits interests or incentive units for key employees should be carefully explained, both economically and for tax purposes with a qualified tax advisor, so existing members understand the potential dilution.
A well‑drafted ownership section ensures that members know exactly what their stake represents, how it can grow or shrink over time, and how their economic and voting rights will play out in real business scenarios.
Management Structure and Authority (Member‑Managed vs. Manager‑Managed)
Management provisions explain who runs the company day to day and how authority is delegated. The operating agreement should specify whether the LLC is member‑managed, manager‑managed, or board‑managed. In a member‑managed structure, all members participate in management, often proportionate to their ownership. In a manager‑managed LLC, one or more managers—who may or may not be members—handle operations. Some mid‑market LLCs adopt a board‑managed model, where a board of managers or directors is given defined powers similar to a corporate board.
Key issues to address include the scope of manager authority versus matters reserved for member approval, the process for appointing, removing, and replacing managers, the term of service and any compensation, and limitations on authority that require member consent for major decisions.
From the members’ perspective:
Balance operational flexibility with control over major corporate events.
Protect “major decision” categories such as mergers, acquisitions, or sale of substantially all assets.
Ensure member approval for issuance of new equity or debt beyond agreed thresholds.
Safeguard rights around significant capital expenditures or entering new lines of business (particularly through a holding company and subsidiary).
Retain control over amendments to the operating agreement and admission or transfer of significant interests.
Tip: Include a detailed schedule distinguishing “ordinary course” decisions managers can make without member consent from “extraordinary” decisions that require a member vote or supermajority approval, or implement negative controls giving broad authority except for certain activities.
A clear management structure ensures that day‑to‑day operations run smoothly while members retain meaningful control over the most important corporate events, striking the right balance between efficiency and protection.
Voting Rights, Quorum, and Deadlock Provisions
At the end of the day, voting rules determine how real power is exercised inside the LLC. The operating agreement should explain how votes are counted, what level of participation is needed to make decisions valid, and how major corporate events are approved. It should also anticipate what happens if members disagree and the company reaches a standstill.
From the members’ perspective, you want clarity on:
For routine matters, is a simple majority enough, or do you need more?
For decisions that fundamentally change your investment, such as mergers or new financing, is there enhanced protection like a two‑thirds or 75% approval requirement?
If ownership is split evenly, how will deadlocks be resolved—through mediation, a buy‑sell process, or by appointing an independent manager with tie‑breaking authority?
Common solutions to break deadlock include:
Mediation or arbitration after a cooling‑off period
Buy‑sell mechanisms such as "Russian roulette ” provisions that force one side to buy or sell
Designating an independent manager or director with tie‑breaking authority
A clear voting framework ensures that day‑to‑day decisions can move forward smoothly while protecting members when the stakes are high, and it provides a roadmap for resolving disputes before they escalate.
Profit and Loss Allocations; Distributions and Tax Matters
For most members, how and when money flows out of the company is the most sensitive part of the operating agreement. This section explains how profits and losses are shared, when distributions are made, and how taxes are handled. It should cover whether distributions are regular or discretionary, whether certain classes of members receive preferred returns, and how the LLC is classified for tax purposes.
From the members’ perspective, you want transparency on:
Whether you will receive tax distributions sufficient to cover your pass‑through tax liabilities (“tax cash‑out”).
Whether management can retain earnings instead of distributing profits, and under what conditions.
How allocations are handled if you invest at a different time or valuation than other members.
Align economic distributions and tax allocations as closely as possible, and clarify how “catch‑up” or “true‑up” distributions will work so members are not left with unexpected tax bills or inequitable payouts.
A well‑drafted profit and tax section gives members confidence that the company’s financial policies are fair, predictable, and designed to protect both economic and tax interests.
Transfer Restrictions, Buy‑Sell Rights, and Exit Provisions
Transfer and exit provisions protect the company and its members from unwanted co‑owners while also providing predictable paths for liquidity. These clauses are especially important for mid‑market LLCs, where members may eventually want to sell part or all of their interest.
Key elements to understand include:
General transfer restrictions, such as consent requirements and permitted transferees
Rights of first refusal (ROFR), allowing existing members or the LLC to match outside offers
Rights of first offer (ROFO), requiring members to offer interests internally before approaching third parties
Tag‑along rights, which let minority members join in a sale by majority members on the same terms
Drag‑along rights, which allow majority members to compel minority members to participate in a sale
Buy‑sell triggers, such as death, disability, bankruptcy, divorce, or breach of the agreement
Exceptions for permitted transfers, such as for estate-planning purposes
Valuation mechanisms, whether by formula, appraisal, or negotiated pricing
From the members’ perspective, clarity matters on:
When and to whom you can sell your interest
Whether you can join a sale of the company (tag‑along) or be compelled to sell (drag‑along)
How your interest will be valued in a forced transfer—fair market value, discounted, or formula‑based
Tip: Stress‑test the valuation and funding mechanics for buy‑sell rights. In companies valued between $5 million and $50 million, (really, even over $1,000,000) life insurance funding is often part of the strategy.
A well‑crafted transfer and exit framework ensures members have both protection against unwanted outsiders and confidence in how their investment can be monetized when the time comes.
Admission of New Members and Issuance of Additional Equity
Growth‑oriented LLCs often bring in new investors, key employees, or strategic partners. The operating agreement should spell out how new members are admitted, whether existing members have rights to maintain their ownership percentage, and how new equity classes affect voting and economic rights.
Key elements to address include:
Conditions for admitting new members, including required approvals and process
Whether existing members have preemptive rights to maintain their percentage in new capital raises
Treatment of profits interests, options, or incentive units for management and employees
The impact of new classes of units on existing members’ voting and distribution rights
From the members’ perspective, you want clarity on:
Whether you have a right of first offer or preemptive right when new units are issued
Whether managers can issue new equity without a member vote, and if so, up to what cap
How new classes of units rank in priority relative to your class for distributions and liquidation
A clear equity issuance framework prevents unexpected dilution and ensures that growth strategies align with member protections, giving confidence that expansion will not erode existing rights.
Member Duties, Non‑Compete, and Confidentiality Obligations
Operating agreements often include provisions that govern member conduct to protect the company’s business and goodwill. These clauses can cover fiduciary duties, non‑competition, non‑solicitation, and confidentiality. They are especially important in closely held or mid‑market LLCs where member actions directly affect enterprise value.
Key elements typically include:
Fiduciary duties, and whether loyalty and care obligations are modified or waived
Non‑competition obligations, including restrictions on competing businesses, scope, geography, and duration
Non‑solicitation rules, preventing members from soliciting employees, customers, or vendors
Confidentiality obligations, requiring members to protect proprietary information and trade secrets
From the members’ perspective, ask:
Are the non‑compete and non‑solicitation covenants reasonable in scope and duration and enforceable under state law?
Are you comfortable with any limitations on your ability to invest in other businesses?
What remedies or penalties apply if you are accused of violating these provisions, such as injunctive relief or discounted buy‑outs?
Tip: For investor or passive members who are not involved in day‑to‑day operations, restrictive covenants may need to be narrowed or tailored (or more practically, set forth in an ancillary agreement) to avoid unnecessary limits on outside business activities.
Clear conduct provisions protect the company’s value while balancing fairness for members, ensuring that restrictions are reasonable and aligned with the business’s long‑term goals.
Information Rights, Reporting, and Inspection
Transparent financial and operational reporting is essential for members, whether the LLC is a closely held family business or a mid‑market company with outside investors. When management is centralized in a smaller group or delegated to a third party, members need reliable information to monitor performance and protect their capital.
Key elements to address include:
Frequency and format of financial statements, such as monthly, quarterly, or annual reports
The budgeting process and delivery of annual business plans
Member rights to inspect books and records, subject to reasonable limitations
Audit rights, including whether financials will be audited and at whose expense
From the members’ perspective, you want assurance that:
The agreement provides a clear reporting schedule with minimum content like income statements, balance sheets, and cash flow reports
You have meaningful inspection rights that allow oversight without disrupting operations
There are remedies if management fails to provide reports or misrepresents information
A strong reporting framework builds trust and accountability, giving members confidence that they can track performance and make informed decisions about their investment.
Dispute Resolution, Indemnification, and Limitation of Liability
No one forms a company expecting conflict, but disagreements among members, managers, or even third parties are a reality in both closely held businesses and mid‑market LLCs. A well‑drafted operating agreement can prevent those disputes from spiraling into costly litigation by setting out clear processes for resolution and defining how liability is handled.
The agreement should outline internal procedures for resolving disputes, such as good‑faith negotiation, mediation, or arbitration before anyone heads to court. It should also specify which state’s law governs the LLC and where disputes will be heard, so members know what rules apply. Indemnification provisions are equally important, protecting managers, officers, and sometimes members when they act in good faith within the scope of their authority.
At the same time, carve‑outs for fraud, willful misconduct, or gross negligence ensure that bad actors cannot hide behind indemnification. Limitation of liability clauses can further reduce uncertainty by capping certain types of claims.
From the members’ perspective, you want:
A clear, cost‑effective process for handling disputes without destroying the business
Comfort that managers are protected when acting in good faith, which encourages qualified individuals to take leadership roles
Confidence that exclusions for fraud or misconduct prevent abuse of indemnification
By addressing disputes and liability upfront, the operating agreement gives members peace of mind that conflicts will be managed fairly and efficiently, protecting both the company and individual investments.
Dissolution, Liquidation, and Wind‑Up
Even for growth‑oriented LLCs, planning for a worst‑case scenario is part of responsible governance. Dissolution provisions ensure that if the company must be wound down, the process is orderly, predictable, and fair to all members.
The agreement should specify the events that trigger dissolution, such as expiration of the LLC’s term, a member vote, sale of substantially all assets, bankruptcy, or judicial decree. It should also describe the wind‑up process, including payment of creditors, reserves for contingencies, and final tax filings.
Perhaps most importantly, it should establish a distribution waterfall that determines the order of payments—creditors first, then return of capital, preferred returns, and finally residual distributions to members. A liquidating trustee or manager may be appointed to oversee the process and ensure compliance.
From the members’ perspective, you should understand:
In what order claims and interests are paid when the company is liquidated
Whether your original capital is likely to be returned before profits are divided
How disputes over valuation of assets or claims will be resolved during wind‑up
Tip: Align dissolution provisions with the economic terms in your capital structure, particularly for preferred equity and secured lenders.
By planning for dissolution in advance, members can avoid confusion and conflict during stressful times, ensuring that even in a wind‑down scenario, their rights and capital are respected.
Putting It All Together
A thoughtfully drafted operating agreement is one of the most important documents for any LLC, whether you are a closely held family business or a company in the $5–50 million enterprise value range. The right structure aligns member interests, minimizes internal conflict, supports capital raising, and positions the company for a successful exit. By contrast, a bare‑bones template or poorly drafted agreement can create risk, weaken your bargaining position, and lead to costly disputes among members.
If you are forming a new LLC, bringing in investors, or updating an existing agreement ahead of a financing or sale, our business law team can help you:
Analyze your current or proposed operating agreement from the member’s perspective
Design ownership, voting, and distribution structures that align with your strategic goals
Negotiate protections around capital calls, transfers, buy‑sell rights, and exits
Coordinate with your tax and financial advisors to ensure cohesive, tax‑efficient planning
A strong operating agreement is more than a legal requirement—it is a strategic tool that protects your investment and strengthens your company’s future. To discuss your operating agreement or broader corporate and M&A needs, contact our firm today to schedule a confidential consultation. Call us directly at (401) 272-8300 or book a consultation through our online booking page to discuss your deal strategy.
