This article takes a look at the fundamentals of an LLC, the difference between an LLC and other popular forms of ownership, and the importance of having a solid Operating Agreement in place.
What is an LLC?
A limited liability company (“LLC”), is a popular form of business entity in California as it provides asset protection to its members while being easier to maintain than a corporation. An LLC may have one or more owners (known as “members”), and may have different classes of owners. In addition, an LLC may be owned by any combination of individuals or business entities. In general, all the members are shielded from individual liability for debts and obligations of the LLC.
An LLC is formed by filing “Articles of Organization” with the California Secretary of State prior to conducting business. A company can be formed on a routine basis usually in about 2-3 weeks, or on an expedited 24-hour basis for an additional filing fee.
Either before or after filing its Articles of Organization, the LLC members must enter into a written Operating Agreement signed by all the parties involved, both managers and members.
An LLC is typically managed by its members, unless the members agree to have a manager handle the LLC’s business affairs. The level of the involvement of the members in the day-to-day affairs is generally established in the Operating Agreement and varies depending on the structure of the business.
An LLC’s life is perpetual in nature. However, the members may agree to a date or event of termination.
What Are Some Differences Between an LLC and a Partnership or Corporation?
The LLC’s main advantage over a partnership is that, like the shareholders of a corporation, the liability of the LLC members for debts and obligations of the LLC is limited to their financial investment. However, like a general partnership, members of an LLC have the right to participate in management of the LLC, unless the LLC’s articles of organization and operating agreement provide that the LLC is to be managed by managers.
One reason LLCs may be preferred over corporations is that LLCs must follow less formalities than corporations by law and do not issue stock. Rather, an LLC’s members sign an Operating Agreement which sets forth the rights, responsibilities, and percentage ownership of all parties involved. Further, LLCs are not required to hold annual meetings or keep written minutes, which a corporation must do in order to preserve the liability shield for its shareholders.
Generally, members of an LLC that is taxed as a partnership may agree to share the profits and losses in any manner. Members of an LLC classified as a corporation receive profits and losses in the same manner as shareholders of a corporation legally organized as such.
An LLC that is taxable as a partnership can achieve both conduit tax treatment and limited liability protection under civil law, similar to an entity taxable as an S corporation. However, an LLC taxable as a partnership does not have the ownership restrictions that apply to entities taxable as S corporations.
It is important to seek tax advice when starting a new LLC, particularly if you reside in California but plan on setting up an LLC in another state, such as Delaware or Nevada. Depending on the circumstances and your activities, your company may still be subject to California state taxes, as the California Franchise Tax Board has complex rules regarding what constitutes “doing business” in California. For more on what constitutes “doing business” in California for state tax purposes, please see this link from the California Franchise Tax Board:
Why is an LLC Operating Agreement Important?
Operating Agreements generally vary in length and detail, depending on the needs of the parties and the nature of the business. This section will highlight why it is important to read through the Operating Agreement and have it tailored to suit your needs. The main point here is that if you are looking to make a significant change in management or ownership, or if something happens in the LLC that you do not like, the first place you will look is the Operating Agreement to see what to do about it.
Note that most LLC Operating Agreements still require written consent for different events, depending on the business conducted by the LLC. For instance, an LLC established for the purpose of purchasing and managing commercial real estate may require consent of 100% of its members prior to taking on debt secured by its property, or selling its property. Often times removing a manager of the LLC may also require a vote and consent from a specified percentage of its members.
Issues such as consent make the Operating Agreement very important, and not a document to be left to D-I-Y websites that send you a boilerplate agreement after formation. The boilerplate LLC Operating Agreement might be a good starting point, but like any partnership agreement, the Operating Agreement should be viewed with a critical eye and negotiated specifically to address key business and partnership issues.
Some of the most frequent LLC issues I see are:
Can I remove my LLC’s manager?
Can I require the other members to invest more money (a capital call)?
What happens if I can’t fund the money required in the capital call?
I want to see where my money has been spent. Do I have a right as a member to request an accounting of the Company?
My business partner and I are 50/50 and we can’t agree on an issue. What should we do?
There are many other issues which come up, and a good lawyer should be able to identify and address those issues most likely to affect you. Parties should exercise caution and not hesitate to seek the advice of legal counsel in drafting an Operating Agreement.
For more information on LLCs and Operating Agreements, please contact Evelyn Ginossi at email@example.com or 310.746.3837.
This article is provided by IBV Advisory Group Inc. for general educational purposes only. The information should not be relied on as legal advice, nor does it serve to create an attorney-client relationship. For legal advice on a specific matter, consult an attorney.