Who should form an LLC?You
should consider forming an LLC (limited liability company) if you are
concerned about personal exposure to lawsuits arising from your
business. For example, if you decide to open a store-front business that
deals directly with the public, you may worry that your commercial
liability insurance won't fully protect your personal assets from
potential slip-and-fall lawsuits or claims by your suppliers for unpaid
bills. Running your business as an LLC may help you sleep better,
because it instantly gives you personal protection against these and
other potential claims against your business.
Not all businesses
can operate as LLCs, however. Businesses in the banking, trust, and
insurance industry, for example, are typically prohibited from forming
LLCs.
Should I choose an LLC or an S corporation?
While
the S corporation's special tax status eliminates double taxation, it
lacks the flexibility of an LLC in allocating income to the owners.
An LLC may offer several classes of membership interests while an S corporation may only have one class of stock.
Any
number of individuals or entities may own interests in an LLC. However,
ownership interest in an S corporation is limited to no more than 75
shareholders. Also, S corporations cannot be owned by C corporations,
other S corporations, many trusts, LLCs, partnerships, or nonresident
aliens. Also, LLCs are allowed to have subsidiaries without restriction.
What is an LLC Operating Agreement?
An
LLC operating agreement allows you to structure your financial and
working relationships with your co-owners in a way that suits your
business. In your operating agreement, you and your co-owners establish
each owner's percentage of ownership in the LLC, his or her share of
profits (or losses), his or her rights and responsibilities, and what
will happen to the business if one of you leaves.
Do I need to have an Operating Agreement?
Although
most states' LLC laws don't require a written operating agreement, you
shouldn't consider starting business without one. Here's why an
operating agreement is necessary:
- It helps to ensure that
courts will respect your personal liability protection by showing that
you have been conscientious about organizing your LLC.
- It sets
out rules that govern how profits will be split up, how major business
decisions will be made, and the procedures for handling the departure
and addition of members.
- It helps to avert misunderstandings between the owners over finances and management.
- It keeps your LLC from being governed by the default rules in your state's LLC laws, which might not be to your benefit.
Must I hold LLC meetings?
Although
a corporation's failure to hold shareholder or director meetings may
subject the corporation to alter ego liability, this is not the case for
LLCs in many states. In California, for example. an LLC's failure to
hold meetings of members or managers is not usually considered grounds
for imposing the alter ego doctrine where the LLC's Articles of
Organization or Operating Agreement do not expressly require such
meetings.
Exceptions to Limited Liability
While
LLC owners enjoy limited personal liability for many of their business
transactions, it is important to realize that this protection is not
absolute. This drawback is not unique to LLCs, however -- the same
exceptions apply to corporations. An LLC owner can be held personally
liable if he or she:
- personally and directly injures someone
- personally guarantees a bank loan or a business debt on which the LLC defaults
- fails to deposit taxes withheld from employees' wages
- intentionally
does something fraudulent, illegal, or clearly wrong-headed that causes
harm to the company or to someone else, or
- treats the LLC as an extension of his or her personal affairs, rather than as a separate legal entity.
This
last exception is the most important. In some circumstances, a court
might say that the LLC doesn't really exist and find that its owners are
really doing business as individuals, who are personally liable for
their acts. To keep this from happening, make sure you and your
co-owners:
- Act fairly and legally. Do not conceal or misrepresent material facts or the state of your finances to vendors, creditors, or other outsiders.
- Fund your LLC adequately. Invest enough cash into the business so that your LLC can meet foreseeable expenses and liabilities.
- Keep LLC and personal business separate.
Get a federal employer identification number, open up a business-only
checking account, and keep your personal finances out of your LLC
accounting books.
- Create an operating agreement. Having a formal written operating agreement lends credibility to your LLC's separate existence.
A
good liability insurance policy can shield your personal assets when
limited liability protection does not. For instance, if you are a
massage therapist and you accidentally injure a client's back, your
liability insurance policy should cover you. Insurance can also protect
your personal assets in the event that your limited liability status is
ignored by a court.
In addition to protecting your personal assets
in such situations, insurance can protect your corporate assets from
lawsuits and claims. Be aware, however, that commercial insurance
usually does not protect personal or corporate assets from unpaid
business debts, whether or not they're personally guaranteed.