Product Supply Agreement: What To Review Before Signing

When launching a new business, founders often focus on product, customers, and growth, but overlook the importance of a basic operating agreement. Many believe forming an LLC and filing with the state is enough, or that a downloaded template will cover all their needs. In reality, inconsistent or incomplete documents can create confusion about ownership, management, and decision-making. This guide explains what a basic operating agreement is, why it matters, what founders should keep consistent across their documents, and when to seek legal support. We cover practical examples, common mistakes, and state-specific caveats so you can avoid costly headaches down the line.

What Is a Basic Operating Agreement?

A basic operating agreement is the foundational contract between the members (owners) of a limited liability company (LLC). It sets out the rules for how the business will operate, who owns what, and how decisions are made. While not always required by state law, an operating agreement is highly recommended for LLCs of any size, including single-member LLCs. It helps clarify each member's rights and responsibilities, reduces the risk of disputes, and can be critical for opening a bank account or attracting investors.

At the federal level, there is no law requiring LLCs to have an operating agreement. The Internal Revenue Service (IRS) and Small Business Administration (SBA) both recognize the importance of clear internal rules, especially regarding ownership, profit sharing, and tax treatment. The IRS may request to see an operating agreement if you apply for an Employer Identification Number (EIN) or elect S corporation tax status. Most states strongly encourage or require LLCs to have an operating agreement, and some states require it to be in writing.

Key topics typically covered by a basic operating agreement include:

• Ownership percentages and capital contributions
• Management structure (member-managed or manager-managed)
• Voting rights and approval thresholds for major decisions
• Profit and loss allocations
• Procedures for admitting new members or handling member exits
• Rules for meetings, record-keeping, and decision-making
• Dispute resolution processes

Even if your state does not require an operating agreement, having one provides a clear reference point if disputes arise and can help demonstrate that your LLC is a separate legal entity. For example, if you are a single-member LLC and want to limit your personal liability, an operating agreement can help show that you are operating the business properly.

Why Consistency Matters in Founders' Documents

Founders often use online templates or draft their own agreements, but inconsistencies between documents can cause major problems. For example, if your operating agreement says one thing about ownership percentages but your state filing or cap table says another, this can lead to disputes or even legal challenges. Investors, banks, and potential partners may also scrutinize your documents for consistency before doing business with you.

Here are some areas where consistency is critical:

• Ownership and Contributions: The ownership breakdown in your operating agreement should match your state filings and any internal spreadsheets or cap tables. For instance, if your operating agreement says Alice owns 60 percent and Bob owns 40 percent, your state records and cap table should reflect the same.
• Management Structure: If your operating agreement says the LLC is manager-managed, but your state registration lists all members as managers, this can create confusion about who has authority to act. For example, in Florida, the Articles of Organization must specify whether the LLC is member-managed or manager-managed, and this should match your operating agreement.
• Signatory Authority: The people authorized to sign contracts or open bank accounts should be clearly identified and consistent across all documents. If your bank sees conflicting information, they may refuse to open an account.
• Tax Elections: If you elect to be taxed as an S corporation with the IRS, your operating agreement should reflect this status and outline how distributions and salaries are handled. The IRS may request your operating agreement if you file Form 2553 for S corporation election.
• Buy-Sell Provisions: Rules for admitting new members or handling member exits should match any separate buy-sell agreements or founder agreements. For example, if your operating agreement requires unanimous approval to add a new member, but your buy-sell agreement says a simple majority is enough, this could create a deadlock.

Inconsistent documents can cause delays in opening bank accounts, obtaining an EIN, or raising investment. They can also make it harder to resolve disputes if the documents do not align. For example, if your operating agreement says one member can bind the LLC to contracts, but your state filing lists two managers, a counterparty may question who has authority.

Practical tip: Create a checklist of all your key business documents (Articles of Organization, operating agreement, cap table, buy-sell agreement, EIN application, bank resolutions) and review them side by side to ensure consistency. Update all documents when ownership or management changes.

Key Elements to Include in a Basic Operating Agreement

While every LLC is different, there are some core elements that should be included in any basic operating agreement. Here is a practical checklist for founders, with examples and state-specific notes:

• LLC Name and Principal Address: Match this to your state filing. For example, if you registered as "Sunrise Ventures LLC" in Texas, use the exact name and address in your agreement.
• Purpose of the LLC: A short description of what your business does. Some states, like New York, require a specific statement of purpose for professional LLCs.
• Members and Ownership Percentages: List all members, their contributions (cash, property, services), and their percentage ownership. For example, "Alice Smith, 60 percent, $6,000 cash; Bob Jones, 40 percent, $4,000 cash." In California, this information is not public, but it should be clear in your internal documents.
• Management Structure: Specify whether the LLC is managed by its members or by appointed managers. Name the managers if applicable. In Delaware, you can have either structure, but you must be clear and consistent across your filings and agreement.
• Voting Rights: State how votes are allocated (by ownership percentage, per member, or another method) and what percentage is needed for major decisions. For example, "Major decisions require approval by members holding at least 75 percent of ownership interests."
• Profit and Loss Allocation: Explain how profits and losses are divided among members. By default, many states require sharing in proportion to ownership, but you can set a different rule if all members agree.
• Bank Accounts and Signatories: Identify who can open and manage the LLC's bank accounts. If you want only one manager to have this authority, state it clearly.
• Meetings and Record-Keeping: Outline how meetings are called, what records are kept, and how minutes are handled. In some states, like Illinois, you must keep certain records available for inspection by members.
• Admitting New Members: Describe the process and approval needed for bringing in new members. For example, "New members may be admitted only with unanimous written consent of existing members."
• Member Withdrawal or Transfer: Set out what happens if a member wants to leave or transfer their interest. Will the LLC buy out the departing member? Is approval needed for transfers?
• Dissolution: Explain how the LLC can be dissolved and how assets are distributed. For example, "The LLC may be dissolved by a two-thirds vote of the members."
• Dispute Resolution: Include a process for resolving disagreements, such as mediation or arbitration. This can help avoid costly litigation.

State caveat: Some states, like New York, require professional LLCs to include specific language about licensure and compliance. In Georgia, you must list the registered agent and office in your operating agreement. Always review your state's Secretary of State website for any additional requirements.

Practical example: Suppose two founders, Maria and Lee, start an LLC in Colorado. They each contribute $10,000 and agree to split profits 50/50. Their operating agreement should state their names, contributions, ownership percentages, how profits are split, who manages the LLC, and what happens if one wants to leave. If Maria later invests another $5,000, the agreement should be updated to reflect the new ownership split.

Common Mistakes Founders Make With Operating Agreements

Founders often make avoidable mistakes when preparing or updating their operating agreement. Here are some of the most common issues, with practical examples and state-specific notes:

• Using a generic template without customizing: Templates can be a good starting point, but failing to tailor the agreement to your business can leave important issues unaddressed. For example, a template may not include provisions for vesting ownership over time, which is common in startups.
• Leaving out key terms: Missing provisions about member exits, dispute resolution, or profit sharing can create uncertainty later. For instance, if your agreement does not specify how to handle a member's death, state law may require the LLC to dissolve.
• Inconsistent documents: Mismatches between your operating agreement, state filings, and internal records can cause confusion and legal risk. For example, if your Articles of Organization in Ohio list three members but your operating agreement only lists two, this could raise questions about who owns the business.
• Not updating the agreement: As your business grows, you may add new members, change your management structure, or make other changes that should be reflected in your operating agreement. For example, if you bring on a new investor but do not update the agreement, their rights may not be clear.
• Failing to get all members to sign: An unsigned agreement may not be enforceable, especially if there is a dispute. In some states, like Texas, courts may look to the signed agreement to resolve conflicts.
• Ignoring state-specific rules: Some states have unique requirements for LLCs, such as publication requirements (New York) or additional disclosures for professional services (California, Arizona).
• Overlooking tax issues: If you elect S corporation status or have complex profit-sharing arrangements, your agreement should address how these are handled. For example, if you want to pay yourself a salary as an S corp, your agreement should specify how this works.
• Not keeping records up to date: Failing to keep signed copies and updated versions can create confusion, especially if members leave or new ones join.

Checklist for avoiding mistakes:

• Customize your agreement for your business and state
• Include all key terms and update as your business changes
• Ensure consistency across all documents
• Get all members to sign and keep copies
• Review state-specific requirements annually

Practical example: A three-member LLC in Illinois failed to update its operating agreement after one member sold their interest. When the business was later sold, the outdated agreement caused a dispute over who was entitled to the sale proceeds. Keeping documents current could have prevented the conflict.

How State and Federal Rules Affect Your Operating Agreement

LLCs are formed under state law, so the rules for operating agreements can vary. At the federal level, the IRS cares about how your LLC is taxed, but not how it is managed. The SBA provides general guidance, but your state's Secretary of State will have specific filing and record-keeping requirements.

Some states, like California and New York, require LLCs to have a written operating agreement. Others, like Delaware, allow oral agreements but recommend written ones for clarity. States may also have default rules that apply if your operating agreement is silent on an issue. For example, if your agreement does not specify how profits are divided, state law may require equal sharing among members.

Here are some ways state and federal rules can impact your operating agreement:

• Filing Requirements: Most states do not require you to file your operating agreement with the state, but you should keep it with your business records. In New York, you must have a written agreement within 90 days of forming your LLC.
• Public Disclosure: Some states require you to list managers or members in your public filings. Make sure this matches your operating agreement. For example, in Florida, the names of managers appear in the public record.
• Tax IDs and EINs: The IRS requires an EIN for most LLCs. Your operating agreement should identify who is authorized to apply for it and manage tax filings. If you have multiple members, the IRS may ask to see your agreement when you apply for an EIN.
• Industry Rules: If you operate in a regulated industry (like healthcare or law), your state may require additional provisions in your operating agreement. For example, professional LLCs in California must include language about licensure and compliance with state boards.
• Foreign LLCs: If your LLC does business in multiple states, you may need to register as a foreign LLC and ensure your operating agreement complies with each state's rules. For example, a Delaware LLC operating in Texas must comply with Texas rules for foreign entities.
• Publication Requirements: Some states, like New York and Arizona, require new LLCs to publish a notice of formation in a local newspaper. Your operating agreement should reflect compliance with these steps.

Always check your state's Secretary of State website for the latest requirements. If you are unsure, consider consulting a legal professional familiar with your state's laws. This is especially important for startups that may be operating in more than one state or planning to raise investment.

Practical example: A tech startup forms an LLC in Delaware but operates in California. Delaware does not require a written operating agreement, but California does. The founders should prepare a written agreement that complies with both states' requirements and keep it with their records in California.

FAQs

Is a basic operating agreement legally required for my LLC?

Most states do not require LLCs to file an operating agreement with the state, but many require you to have one in your records. Even if not required, having a written operating agreement is strongly recommended to clarify ownership, management, and decision-making. Some states, like California and New York, do require a written agreement for LLCs. Always check your state's requirements.

What happens if my operating agreement conflicts with my state filing?

If there is a conflict between your operating agreement and your state filing, it can create legal uncertainty. State law may override your agreement in some cases, or the inconsistency could delay banking, tax filings, or investment. Always ensure your documents are consistent and update them as needed. For example, if your Articles of Organization list three members but your operating agreement lists two, clarify and update both documents.

Can I use an online template for my operating agreement?

Online templates can be a helpful starting point, but they should always be customized to fit your business and comply with your state's requirements. Do not rely solely on a generic template, especially if your business has multiple members or unique arrangements. Review your template with a legal professional if possible.

Do single-member LLCs need an operating agreement?

Yes, it is a good idea for single-member LLCs to have an operating agreement. It helps establish the LLC as a separate legal entity, which can protect your personal assets and clarify how the business is managed. Some banks and investors may require it before working with your LLC. In some states, like California, a written agreement is required even for single-member LLCs.

How often should I update my operating agreement?

Review your operating agreement at least annually, and update it whenever there are changes in ownership, management, or business activities. Make sure all members sign any updated agreement and keep copies for your records. This helps avoid confusion and ensures your documents remain enforceable.

Key Takeaways

• A basic operating agreement is essential for LLCs, even if not legally required in your state.
• Keep ownership, management, and approval rules consistent across all business documents.
• Customize your agreement to fit your business and update it as things change.
• Check your state's Secretary of State website for any special requirements.
• Consider legal support if you have multiple members, complex arrangements, or plan to raise investment.

If you have questions about preparing or updating your basic operating agreement, or want to make sure your documents are consistent and ready for growth, contact our team at (888) 449-8437 or team@sprintlaw.com. Where legal services are required, they are delivered by licensed lawyers at trusted US law firms through the Sprintlaw platform.