A limited liability company (“LLC”) is the most popular statutory business entity in the United States. It is also the newest, with the first LLC statute enacted in Wyoming in 1977. Most other states did not catch on and establish their limited liability statutes until the early 1990s.
It is essential to have the advice of a business attorney when you form an LLC. An experienced attorney can help you anticipate possible problems and prevent many of the disputes we see LLC members embroiled in when they did not consult with an attorney during formation.
If you are forming an LLC, especially if it is a multi-member LLC, please contact a seasoned business attorney first.
What Is an LLC?
Before states created LLCs, multi-owner businesses were either partnerships or corporations. A partnership offers the tax advantage that business income or loss flows straight through the business to the partners and is only taxed once, at the individual level. But, in a partnership, the partners can be held liable for the business’s debts and liabilities.
On the other hand, corporations provide a liability shield. If the corporate stakeholders follow corporate formalities, the law generally protects them from individual liability for the company’s debts and liabilities. But, the law also sees corporations as separate and distinct legal entities from their stakeholders and taxes corporate income both at the corporate level and then again when distributed as salaries or dividends to individuals.
States invented the LLC to provide owners with both liability protection and pass-through taxation.
What Are the Legal Requirements To Start an LLC?
The LLC members must pay a filing fee and register the LLC with the Secretary of State. They must pick a name for the business and also choose a registered agent – the person responsible for accepting any legal process.
Unlike a corporation, an LLC does not have shareholders or shares. It does not need to have a board of directors or annual business meetings. But, an LLC is still separate and distinct from its members. Therefore, the primary formality needed to protect the members from liability is to keep all the LLC’s finances separate.
The LLC should have a bank account and its own set of books. Income into the LLC and distributions from the LLC should each be recorded. LLC members should not use their bank accounts for LLC business. And they should not use the LLC account to pay personal expenses, such as home mortgage or groceries. This commingling of funds is one of the main ways we have seen LLC members lose liability protection.
Another way an LLC can lose liability protection is by not adequately insuring or capitalizing the company. It is important to make sure the company has enough insurance or capital on hand to cover reasonable liabilities. If not, an enterprising plaintiff’s attorney can argue that the inadequately unfunded LLC only exists as a liability shield and not as a legitimate business.
You Should Have a Lawyer Prepare an Operating Agreement
An LLC is not legally required to have an operating agreement, but it should. An operating agreement is a contract between the LLC members defining their relationship with each other and their relationship to the LLC.
Many disputes between LLC members happen because they either did not create an operating agreement or they used a poor template they downloaded off the internet. If the LLC members reach an impasse without an operating agreement, a lawsuit could be necessary to resolve the issue. Depending on the state, a court could be forced to break a tie or even dissolve the company. An experienced business attorney can help you anticipate possible issues and deal with them in advance in the operating agreement.
Here are just some of the issues to deal with in an operating agreement:
- What is the ownership percentage?
- What capital contributions are required?
- How will profits and losses be allotted?
- Who decides when distributions are given?
- Who handles day-to-day business decisions?
- What are day-to-day decisions versus larger decisions?
- How are larger decisions voted upon?
- What happens in the event of a tie?
- What happens if a member wants to sell shares?
- What happens if a member is done and wants to force the other members to buy shares?
With just this short list, it is easy to see that a well-crafted operating agreement can prevent significant conflict between members. Sadly, it is too often we see spouses, friends, or family go into business together without clearly defining each member’s rights and responsibilities. We work hard with clients to proactively prevent those situations.
Build a Relationship for Your Future Business Needs
The two most important reasons to work with an attorney when forming your LLC are to 1) create a solid operating agreement, and 2) make sure you follow the minimum business formalities to keep your liability shield. When you partner with an attorney early in the life of your business, your attorney can start to know your business inside and out. That way, your business attorney can help you prevent problems before they occur.