In order to open an LLC in Kentucky you must submit Articles of Organization to the Kentucky Secretary of State. You might also need to obtain permits or licenses, and your business should also have an operating agreement. This document isn’t technically required, but is highly recommended.

What is an LLC Operating Agreement?

An operating agreement is an internal legal document that sets out how your limited liability company functions. It covers aspects such as ownership interests, roles and responsibilities, voting procedures, distribution payments and more. 

By drafting an operating agreement that clearly explains these matters, you can better ensure your business can run well during both easy and difficult times. The document can prove invaluable if a major disagreement arises amongst owners (members).

What’s the Difference Between an Operating Agreement and Articles of Organization?

Your LLC’s Articles of Organization get filed with the Kentucky Secretary of State, and inform the state of your new business. An operating agreement is an internal document that your LLC keeps on file. It covers operational and decision-making aspects of your business, which aren’t part of the Articles of Organization.

Why is an Operating Agreement Important for Kentucky LLCs?

While Kentucky doesn’t technically require that LLCs have an operating agreement, there are several good reasons to draft and sign one. 

Having an agreement ensures that all members understand the business arrangement, and also serves as a binding document should disagreements arise. It can also be useful when making major decisions about expansion, contraction, investments or even dissolution. 

In all of these matters, not having an operating agreement can result in unresolved disputes, which could leave members bitter, hamper the business’s operations, and potentially result in expensive lawsuits. 

Even if you don’t anticipate disagreements, it’s wise to have an operating agreement just in case. Death, divorce, personal financial troubles, and other unforeseen circumstances can lead to disputes.

You might also be required to have an operating agreement if applying for financing, as some lenders will request to see one. It’s wise to have one regardless of whether your LLC will be utilizing debt, though.

Key Components of a Kentucky LLC Operating Agreement

A good operating agreement will cover many different aspects of owning an LLC. The following are some standard sections that should be included in most agreements.

Ownership Structure

Each owner should be identified as a member (i.e. owner) of the LLC. Also include each member’s ownership percentage, what contributions they’re responsible for, and what distributions they’ll be entitled to. Make sure to cover both initial contributions and potential future contributions that might be needed.

The ownership structure of solo-member LLCs and small LLCs where members have equal shares is pretty straightforward. This section can become complex if members have different ownership percentages, make different contributions, and are entitled to different types of payments, though.

Member Roles and Responsibilities

Before discussing each member’s responsibilities, first determine whether the LLC will be a member-managed or manager-managed business. Member-managed means that all owners participate in the business’s daily operations. Manager-managed means that one or a few owners run operations.

If setting up a manager-managed LLC, determine which members are active managers and which are passive investors. It’s assumed that all members are active managers if member-managed.

You can also go into some detail about each member’s financial obligations, operational responsibilities, and other role-related responsibilities. It can be helpful to identify specific domains if multiple owners will run operations.

Voting Rights and Decision-making

This section is for the big decisions, like business expansion, major investments, large contract agreements, and business loans. These are just a few of the decisions you could have to make as a business owner.

Perhaps the most critical part of this section is voting power. Explicitly state what each member’s voting rights are, and keep in mind that voting rights can be different from ownership stake. 

Also include what can trigger major decisions, and the process of making those decisions. The process typically includes who can call meetings, quorum requirements, and how to resolve stalemates. True stalemates that leave members in a deadlock might be resolved through arbitration or mediation.

Additionally, include provisions for how the operating agreement can be amended in the future. This process will likely be similar to how other business decisions are made, but there might be some additional stipulations for changing such a foundational agreement.

Profit and Loss Distribution

Decide how profits and losses are to be shared among members. Many LLCs divide profits based on ownership percentages, but you don’t have to use the same proportion. Some members might be entitled to more or fewer profits, or they might receive preferred distributions before others do.

Don’t just plan for profits, but go through the same process for losses too. Furthermore, include when profits and losses are distributed as well.

Dissolution Terms

Whether you intend to eventually dissolve the LLC or not, include terms for going through dissolution. This should cover how assets and debts are to be distributed, and what events could trigger dissolution. Just be sure that these terms are in agreement with the voting section.

How to Create an LLC Operating Agreement in Kentucky

Creating an LLC operating agreement is a multi-step process, but no one step is too difficult. The process is especially easy if you use an LLC formation service, or if you consult a business attorney who practices in Kentucky.

1. Basic Information: Gather basic information about each member if you don’t already know their personal details. You’ll want to have full names, contact numbers, and initial contribution responsibilities (financial or other) for each member. 
2. Negotiate: Many of the items covered in an operating agreement involve some (or a lot of) negotiation beforehand. All members should agree on ownership percentages, voting rights, distributions, and the other sections before actually writing the agreement.
3. Write: Actually draft the operating agreement. While you technically can do this yourself, it’s recommended that business owners use either an LLC formation service or a business attorney. Most business owners aren’t well-versed in what to include, what not to include, and how to spell out details in legalese. This is a legally binding document that you don’t want major mistakes in.
4. Sign: All members must sign the operating agreement. It’s not necessary to have the agreement notarized.
5. Store: Keep the operating agreement in a safe location, and create at least one backup copy. A best practice is to have one paper copy filed somewhere, one digital copy saved in the cloud, and for each member to have their own copy.

Whether you should use an LLC formation service or an attorney to create an operating agreement largely depends on the complexity of your business structure. 

A formation service should have a template that can be customized for your business, and this solution works for many Kentucky LLCs. This is probably the most suitable option if you have a single-member LLC, or a multi-member LLC with fairly straightforward ownership, voting and distribution arrangements. 

A business attorney might be necessary if your LLC has many owners, or if there are some complex ownership, voting or distribution arrangements. 

Kentucky-Specific Considerations

There are three Kentucky-specific factors that you should be aware of when creating your operating agreement.

• State Laws: The state laws governing LLCs are the Kentucky Revised Statutes (KRS) Chapter 275. Your operating agreement must comply with these, and these laws will be the default wherever your agreement is silent on matters. Consult a business attorney if you have any questions about specific statutes.
• Equitable Distribution: Kentucky is an equitable distribution state. During divorce, the court divides assets according to what it deems equitable and fair – not necessarily equally between spouses.
• This generally means that a member’s ownership stake probably won’t revert to their spouse in the event of divorce. That’s not absolutely guaranteed, however, as courts consider many factors when determining what’s equitable and fair. Address this in your operating agreement if you have a multi-member LLC (an attorney can help).
• Duration:  Kentucky LLCs are presumed to exist indefinitely unless stated otherwise. If you intend to dissolve the LLC at a set time or under certain conditions, explicitly state those terms.

Final Thoughts & Next Steps

Having a well-written operating agreement can keep your LLC running smoothly during normal times, and is especially helpful when problems arise. Whether you’re facing arguments between members, the death or divorce of a member, something good like expansion, or lawsuits, an agreement can be extremely useful during these times.

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