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Operating Agreements & Bylaws

The state filing creates the entity. The operating agreement (for an LLC) or the bylaws plus stockholders' agreement (for a corporation) determine how it actually runs — who decides what, how money flows, what happens when someone wants out, and what the default rules are when the document is silent. Most disputes between owners trace back to ambiguity or omission in these documents.

What these documents do

State statutes provide default rules for LLCs and corporations. If your operating agreement or bylaws are silent on a question, the statute fills the gap — and the statutory default is often not what the owners would have chosen if asked. Profit allocations default to ownership percentage. Voting defaults to per-capita (one member, one vote) or per-share. Buyouts default to whatever the statute provides, which is usually fair market value determined by appraisal after litigation. The point of a customized governance document is to replace these defaults with rules the owners actually want.

Most states allow operating agreements and bylaws enormous flexibility. A few provisions are mandatory or limited (you can't eliminate the implied covenant of good faith and fair dealing in most states; some jurisdictions limit how far you can waive fiduciary duties). Within those bounds, the owners can structure almost anything.

LLC operating agreement

An LLC operating agreement is a contract among the members (and between members and the LLC) governing how the LLC operates. Some states require one in writing (New York, California, Delaware in practice); most don't, but every multi-member LLC should have one regardless. A single-member LLC should still have one — it documents the separation between owner and entity and helps preserve limited liability.

Core sections in a typical LLC operating agreement:

Corporate bylaws

Bylaws are the corporation's internal rulebook. They cover the mechanics of corporate governance: how shareholders meet and vote, how directors are elected and how the board operates, what officers exist and what they do, when annual and special meetings occur, quorum requirements, indemnification of directors and officers, and amendment procedures. Bylaws are adopted by the initial board of directors after incorporation, often as part of an organizational consent.

Bylaws are deliberately generic. Most of the substantive deal terms between shareholders — transfer restrictions, voting agreements, drag-along rights, preemptive rights, special approvals — live in a separate document, usually called a Stockholders' Agreement (or Shareholders' Agreement, or Voting Agreement plus Right of First Refusal/Co-Sale Agreement in VC structures). The bylaws stay relatively stable; the shareholders' agreement evolves with each financing.

Core sections in typical corporate bylaws:

Stockholders' agreements

The stockholders' agreement is where the deal terms between owners live. In an early-stage corporation, this might be a few pages covering vesting, right of first refusal, and drag-along. After a Series A financing, this gets layered with separate documents: a Voting Agreement (drag-along, board composition), an Investors' Rights Agreement (registration rights, information rights, preemptive rights), and a Right of First Refusal and Co-Sale Agreement (transfer restrictions). Together these are usually called the "ancillary agreements" or "rights agreements".

Even a two-founder corporation with no outside investors should have a written agreement covering: vesting schedule (typically 4 years with a 1-year cliff), what happens if a founder leaves (unvested shares forfeited; vested shares may be subject to repurchase rights), right of first refusal on transfers, drag-along on a sale, and tag-along to prevent one founder from selling alone.

Voting and decision rights

The most-litigated provisions in any governance document. Three layers:

Default actions. Day-to-day operating decisions made by management (officers, manager, or managing member) without explicit vote.

Board or member-level actions. Decisions requiring board approval for a corporation or member vote for an LLC: hiring/firing officers, approving annual budget, taking on debt above a threshold, entering material contracts, declaring distributions.

Supermajority or unanimous actions. Decisions requiring more than a simple majority — often 2/3 or unanimous — for fundamental matters: amending the operating agreement or bylaws, selling substantially all the assets, merging, dissolving, admitting new members, issuing new equity, related-party transactions. After VC investment, the preferred stockholders typically get separate "protective provisions" requiring their consent for many of these.

Two-owner 50/50 splits are particularly fragile. If the two disagree, nothing can happen and no statute resolves the deadlock cleanly. Common fixes: a tie-breaking mechanism (a third member or director with deciding vote on specific topics), a buy-sell with shotgun clause, or a defined deadlock-resolution procedure. Better still: avoid 50/50 splits. A 51/49 or 60/40 has a clear decision rule.

Distributions and capital accounts

In an LLC taxed as a partnership, allocations of profit and loss are governed by Section 704(b) of the Internal Revenue Code and the regulations under it. The phrase "substantial economic effect" is the gatekeeper: allocations either follow the statutory safe harbor (which requires maintaining capital accounts and liquidating in accordance with them) or follow the "partners' interests in the partnership" (a facts-and-circumstances test). Most operating agreements adopt the safe harbor and use a target-allocation method that allocates whatever is necessary each year to true up capital accounts to the desired economic result. This is intricate and almost always drafted by a tax attorney.

Cash distributions to LLC members come in several flavors: tax distributions (paid to cover members' tax liability on allocated income, often quarterly), preferred returns (paid to investors before common members share), and discretionary distributions (declared by the manager when cash is available). The operating agreement should specify the order ("waterfall") and the conditions.

For a corporation, distributions are dividends declared by the board. C-Corps pay dividends from after-tax earnings; S-Corps' distributions track allocated income with adjustments. Preferred stock dividends, if any, have priority over common.

Transfer restrictions

Without restrictions, members or shareholders can typically sell their interests to anyone. This causes problems: a competitor could buy in, a passive owner could sell to someone the others won't work with, a divorce could give an ex-spouse half the equity. Standard restrictions:

Exit and dissolution provisions

Three exit modes any closely-held entity should handle.

Owner exits (others continue). Departing owner is bought out. The agreement should specify the trigger events, the valuation method (fixed formula, appraisal, agreed-upon amount updated annually), the payment terms (lump sum, installment with note, payable over years), and what happens to voting and economic rights between trigger and payment.

Sale of the company. Drag-along, board approval thresholds, deal-process provisions. For VC-backed companies, sale provisions are heavily negotiated as part of preferred stock terms.

Wind-down and dissolution. Triggers (unanimous consent, super-majority, court order, expiration of stated term, deadlock), wind-up procedure, priority of distributions (creditors first, then capital contributions, then profits per the allocation rules), and the timeline for filing dissolution paperwork with the state.

Fiduciary duties and indemnification

Directors and officers of a corporation owe fiduciary duties — primarily duty of care (informed decision-making) and duty of loyalty (no self-dealing without disclosure and approval) — to the corporation and its shareholders. LLC managers owe similar duties under most state statutes; Delaware allows operating agreements to limit or eliminate fiduciary duties (other than the implied covenant of good faith and fair dealing). This flexibility is one reason Delaware is the popular choice for joint ventures and investment vehicles where parties want to define their obligations narrowly.

Indemnification provisions in bylaws or operating agreements obligate the entity to indemnify directors, officers, managers, and (often) members against expenses and judgments arising from their service. Most state statutes set the maximum scope. Director and Officer (D&O) insurance backs this up; the entity may also "advance" defense costs subject to repayment if indemnification is ultimately not available. Negotiated indemnification provisions are standard for outside directors.

Amendment mechanics

Operating agreements and bylaws specify who can amend them and by what vote. Common defaults: bylaws can be amended by the board (with shareholders also having the power); LLC operating agreements require majority or super-majority member consent. Provisions that protect specific owners or specific classes (preferred stock terms, minority protections) often require a higher threshold or consent of the protected party. When negotiating, the amendment clause matters as much as the substantive clause — a protection that can be amended by the majority isn't a protection.

Templates vs custom drafting

For a single-owner LLC with no employees, a free template (Secretary of State sample, library form, basic online service) is functional. For two or more owners, any vesting arrangement, anticipated outside investment, or non-standard economics, a template is a starting point at best. The economic decisions inside an operating agreement — allocations, distributions, transfer triggers, valuation method, drag-along threshold — reflect the deal between owners. Using a generic template means accepting whatever the template drafter assumed.

The National Venture Capital Association (NVCA) publishes standard model documents for venture financings, including the Voting Agreement, IRA, and ROFR/Co-Sale. These are the de facto industry default in priced rounds and are reasonable starting points; the negotiation is over which provisions and what numbers fill in.

FAQ

Do we need an operating agreement if we have only one member? Not legally required in most states. Get one anyway: it documents separation between owner and entity for liability purposes, names the responsible party, and addresses what happens if the owner dies.

Can we have an oral operating agreement? Some states allow it; some don't. Even where allowed, oral agreements are nightmares to enforce. Always write it down.

What's the difference between operating agreement and bylaws? Operating agreement is for LLCs; bylaws are for corporations. They serve similar roles but are governed by different statutes and have different default rules.

Who signs the operating agreement? All members. New members sign a joinder when they're admitted.

Do these documents get filed with the state? Generally no. They're internal documents. Some states require LLC operating agreements but don't require them to be filed.

How often should these be updated? When the ownership changes, when the business changes materially, or when a provision proves unworkable. Many small companies operate for years on the original document; that's fine if the original was right.