Why the LLC Kicks Ass!!!!
(Which business entity is right for you, Part 2)
A “Limited Liability Company” (“LLC”) is a bit of a hybrid entity in that it allows for “pass through” taxation but offers the liability protection that is often the basis for creating an entity. The LLC might actually offer more liability protection than a C-corp due to the fact that there are no built in fiduciary duties in an LLC.
LLC’s can accomplish all of the same functions, including holding property, owning subsidiaries, engaging in any type of business. As a for-profit the LLC is still eligible for the same certifications and/or funding that a C-corp is. The one thing to consider is whether or not your business plan includes Venture funding. Most seed and angel organizations are comfortable with the LLC, but many venture funds like the C-corp. This is mostly because of the board membership and various share type options.
One of the reasons that I love the LLC is that you can get creative with it and have multiple levels of management power, profit distributions, and voting power. In the typical LLC, you have members (passive owners), managers (run the day to day and make most decisions), or managing members (they do both). Managers make all the decisions except for the major ones requiring a member vote and profits/losses are distributed based on equity ownership. This doesn’t have to be the case though. You can customize your operating agreement to vary the amount of power the managers have versus the members. You can have profit and loss allocations that differ from equity ownership, which is particularly helpful when someone is working in the business and someone else is not. Just make sure you have a formula and justifiable reason for the discrepancy between profits/losses and ownership. You don’t want an audit.
You can also create different classes of members. So you can have voting and non-voting, managing and non-managing, or anything in between. As long as the rights and responsibilities are spelt out in your operating agreement and not violating any state laws, you can run your business exactly as you would like to.
Additionally, an LLC’s yearly maintenance is relatively simple and does not require the same formalities as a Corporation. You file your annual statement and keep good business records. As opposed to the required annual board meetings and shareholder meetings, and the resolution drafting, etc. that is required by the C-corp, the LLC is very light on the corporate governance requirements. This is especially beneficial when there is only one or a small number of owners and you have to send yourself a notice of the shareholder meeting, record that you showed up, what you discussed with yourself and what you decided to do. J
LLC’s are also useful to bring two or more business entities together for joint ventures. If two businesses (LLCs or corporations) want to form a venture for a project or business, they can form an LLC as the joint venture to execute that particular project or business. This will allow profits and losses from the joint venture (the LLC) to flow directly to the respective entities, and at the same time can shield the owner/ entities and their other businesses from liabilities of the venture.
The majority of businesses are finding this to be the ideal structure due to the flexibility and low maintenance. While the LLC is still considered to be a “new” entity, it has been widely adopted and in use for many years now, so most of the mystery has dissipated. Most states allow a conversion from the LLC to a corporation in the event that need ever arises.
As a result of all the above (and below), I find that I am consistently recommending this entity type to the majority of my clients and that the LLC is capable of bending to meet their unique needs. In short, well not quite, this blog is two pages long…..the LLC Kicks Ass!
Advantages:
- An LLC can be treated as a partnership for tax purposes with the liability of the Member limited to his/her investment.
- An LLC shields Members from personal liability.
- The LLC is flexible. Contributing Members can make non-taxable contributions of appreciated property without regard to whether the contributing Members are in control and the LLC can make disproportionate distributions of money and property to its Members. Profits, losses, voting rights and capital can be allocated in different ways among the members.
- Potential avoidance of self employment taxes (if you are a completely passive owner).
- An LLC is not required to hold Annual Shareholders/Directors meetings or comply with other corporate formalities.
- Charging Order: If a person with an interest in an LLC is involved in a lawsuit and loses, the judge/jury may award damages to the other party. However, under most LLC statutes, all the creditor can recover against the Defendant’s interest in the LLC is a Charging Order. A Charging Order will give the creditor cash only when the LLC elects to distribute it. The tax repercussions of a Charging Order make it unattractive as the creditor can be taxed on the income attributable to that share, even though no cash is distributed, and most attorneys will not have their customers accept such a lien.
Disadvantages:
- Organizational and Operating requirements vary from state to state.
- Some states impose higher filing fees and annual maintenance fees or income and franchise taxes than are imposed on Corporations. Also, state tax treatment may not follow federal tax treatment.
- Members may not have limited liability in states that do not recognize Single Member LLC’s.
- Due to the relative newness of LLCs, there is still a relative void of reliable case law and some unclear issues and variations between states as to treatment of LLCs, especially regarding creditors’ rights.
