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 100 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.
