Small signal stability of inverter based droop controlled microgrid is a major problem from past decade. In this work, an optimal state feedback controller is designed to improve the stability of the two inverter based test microgrid. The detailed full order small signal model of the test microgrid is developed in state space considering network and load dynamics. Eigen value and sensitivity analysis is done to find out the states which affects the stability of the system and their respective participation in shaping the critical modes of the microgrid. Linear quadratic regulator (LQR) based an optimal controller is then implemented into the single inverter model which provides a state feedback to the open loop system to enhance stability. Eigen value analysis is done using MATLAB to prove that the designed controller improves the dynamic response of the individual inverter by providing sufficient damping to the oscillatory modes. Hence it increases the overall stability of the microgrid. © 2017 IEEE.