The LLC is one of the most flexible business structures available — and that flexibility is both its greatest strength and its most common source of problems. Because the law gives LLC members wide latitude to structure their company however they choose, the LLC agreement that governs an LLC carries more weight than most founders realize. When it’s done well, it provides clarity and protection. When it’s missing or thin, that flexibility becomes a liability. Different states call this agreement by different names. Delaware calls it a LLC Agreement. Minnesota calls it an Operating Agreement. They also used to be called Member Control Agreements. For ease of discussion, we use LLC Agreement regardless of the state of organization.
If you’ve formed an LLC or are considering one, understanding the core governance documents — what they are, what they should cover, and where gaps tend to create problems — is worth the time before a dispute arises or a capital raise brings them under scrutiny.
Why LLC Governance Is Different From a Corporation’s
Corporations come with a built-in governance framework established by state law. There are default rules for how boards operate, how shares are issued, and how decisions get made. Founders can customize those rules through their certificate of incorporation and bylaws, but the statutory baseline provides structure even when documents are thin.
LLCs work differently. State LLC statutes generally provide only minimal default rules, and those defaults are often poorly suited to the realities of a multi-member business. The LLC agreement — not the state statute — is the primary document governing how an LLC operates. If the LLC agreement doesn’t address something, the answer may be unclear or governed by defaults that don’t reflect what the members actually intended. In addition, in many states an LLC agreement can be created simply by the members actions and communications. Another reason to have an LLC agreement that makes the rules clear.
This is why a well-drafted LLC agreement isn’t optional — it’s the foundation of how the business works.
The LLC Agreement: The Document That Governs (almost) Everything
The LLC agreement is the LLC’s central governance document. It establishes who owns the company, how decisions are made, how profits and losses are allocated, and what happens when things don’t go according to plan.
LLC’s are created by filing a certificate of organization in the applicable jurisdiction. Some states call them articles rather than certificate, but it’s the same basic idea. Certificates of Organization are usually very basic, leaving most of the work to the LLC agreement.
Ownership in an LLC is represented by membership interests rather than shares of stock. The LLC agreement should clearly define each member’s percentage interest, how those interests were issued, and what the members contributed in exchange — whether that’s cash, property, or services. Ambiguity in any of these areas creates risk, both in the day-to-day operation of the business and in the event of a dispute. Some LLCs create “units” to represent the percentages, usually in an effort to act like a corporation with its shares. More often than not, these units can cause more trouble then they are worth and we normally recommend expressing ownership in percentages.
Another difference is that LLCs don’t normally have “authorized shares” like a corporation. There is usually no upper limit of shares that can be issued unless it’s stated in the LLC agreement. We occasionally see LLCs describe a cap on the total number of units, again like a corporation, but its not typical and can cause confusion when otherwise dealing with a LLC where most things are expressed as percentages.
Decision-making is another area where LLC agreements do heavy lifting. LLCs can be managed by their members directly or by one or more designated managers. The LLC agreement should specify which structure applies, what decisions require unanimous consent versus a simple majority, and what authority individual managers or members have to act on behalf of the company. Without this clarity, basic business decisions can become contested.
This is another difference from a corporation, with a board, officers and shareholders each having different roles and rights. In a member managed LLC, each member can have rights to bind the LLC and act for it. Decision making can require a vote of the members for even basic activities. We do not usually recommend this structure. The normal way for a LLC to govern is to appoint one or more managers to act for the LLC. This is similar to a combined board and officer role in a corporation. In this model, the members only vote on certain high level activities and do not have any day to day control. While a LLC can have a board of managers and be board managed, similar to a corporation, this is less typical. If members are worried about what the managers can approve without their input, those should be addressed in the LLC agreement.
What a Strong LLC Agreement Should Address
Beyond ownership and decision-making, a well-drafted LLC agreement covers several areas that matter significantly as a business grows.
Transfer restrictions govern whether and how members can sell or transfer their interests. Without them, a member could sell their stake to an outside party without the other members having any say. Most LLC agreements include rights of first refusal that give existing members the ability to purchase an interest before it moves to a third party.
Buyout provisions address what happens when a member wants to leave, is removed, or dies — establishing how the departing member’s interest is valued and purchased. Without them, a member’s departure can create significant uncertainty about ownership and control.
Vesting and capital contributions round out the picture. Tying membership interest to continued service (if they are an active participant rather than a passive investor) through a vesting schedule protects the company if a member leaves early. The agreement should also clearly document what each member contributed and what future contribution obligations, if any, exist.
Common Gaps That Create Problems
The most significant governance problems in LLCs share a common thread: the LLC agreement either doesn’t exist in final executed form, was pulled from a template without customization, or hasn’t been updated as the company evolved.
A single-member LLC that brings on a second member without updating its LLC agreement is a surprisingly common scenario. So is a multi-member LLC LLC on a handshake understanding of who owns what, with no signed agreement to document it. When capital, a new partner, or a dispute enters the picture, that uncertainty becomes expensive to resolve.
Investors reviewing an LLC will examine the LLC agreement carefully — looking for the same thing they look for in any governance document: clarity, completeness, and consistency with what they’ve been told.
A Note on LLCs and Capital Raising
As discussed in the context of the Qualified Small Business Stock article in this series, the LLC structure carries meaningful limitations for companies planning to raise institutional venture capital or pursue certain tax-advantaged exits. Most institutional investors prefer or require a C-corp structure, and QSBS benefits — which can represent significant tax savings at exit — are unavailable to LLC members. Switching from a LLC to a c-corp immediately before funding closes is a common scenario.
That said, many businesses are well-suited to the LLC structure and raise capital effectively within it. The governance considerations here apply regardless of whether a capital raise is on the horizon — a well-structured LLC agreement is simply good business practice.
If you’re forming an LLC and want to make sure your LLC agreement reflects how you actually intend to run the business, or if you have an existing LLC whose governance documents need a review, we’re happy to work through it with you.
Frequently Asked Questions
Does an LLC need an LLC agreement?
Technically, many states don’t legally require one — but operating without one is a significant risk. Without an LLC agreement, your LLC is governed by default state rules that may not reflect your intentions. For any multi-member LLC, a well-drafted LLC agreement is essential.
What is the difference between a member-managed and manager-managed LLC?
In a member-managed LLC, all members have authority to make decisions and act on behalf of the company. In a manager-managed LLC, one or more designated managers — who may or may not be members — hold that authority. The LLC agreement should clearly specify which structure applies and what each party’s authority covers.
What happens to an LLC membership interest if a member wants to leave?
That depends entirely on what the LLC agreement says. A well-drafted agreement will include buyout or redemption provisions that establish how a departing member’s interest is valued and purchased. Without those provisions, a member’s departure can create significant uncertainty about ownership and control.
Can an LLC raise venture capital?
It can, but most institutional venture investors prefer or require a C-corp structure. Some investors won’t invest in LLCs at all, and others require conversion to a C-corp as a condition of investment. If institutional venture capital is part of your plan, it’s worth considering entity structure carefully at formation. It is common to start as an LLC and convert to a C-corp when an investment is about to close.
What should an LLC agreement cover?
At a minimum: ownership percentages and how interests were issued, decision-making authority and voting thresholds, transfer restrictions, buyout provisions for departing members, profit and loss allocation, and any vesting or contribution obligations. A template pulled from the internet rarely covers these areas adequately for a real business.
