A limited liability company, also referred to as an "LLC", is as it says; a means of carrying on an endeavor with limited liability to its principals. The LLC is a hybrid business entity that combines many of the best features of corporations with those of partnerships. Like a corporation, an LLC is a separate legal entity distinct from its owners; thus removing the owners and managers from any personal liability for the company's debts or obligations. Unlike a traditional, or "C" corporation, an LLC passes its income or losses through to its members. This places the tax impact of the activities of the LLC upon the members and not on the LLC entity.
Two primary documents define the LLC. The LLC comes into existence when a Certificate of Formation is filed with the Delaware Secretary of State. The framework of the LLC is defined by the operating agreement also known as the Limited Liability Company Agreement. The day-to-day business of the Limited Liability Company is conducted by its Manager or Co-Managers and is governed by the operating agreement. This written agreement among owners allows the ability to create a customized management structure clearly outlining the economic relationship among the owners. Non-regular business of the Limited Liability Company, (borrowing money or making a major capital expenditure, for example) may with proper authority set out in the LLC Agreement, unlike the Corporation which requires meetings and minutes, be accomplished directly by the Manager.
The important fact to remember in operating the Limited Liability Company is to treat it as an entity separate from the members. If the members or managers act as if they are the Limited Liability Company, there exists the possibility that a court will set aside the liability protection and look to the members for individual liability. The Limited Liability Company should have its own checking account, its own insurance policies and contract in its own name. When signing for the Limited Liability Company, the Manager should always sign as manager in the style:
"My Limited Liability Company"
By John Smith, Manager
The LLC existence will be reinforced if the members do not commingle their funds with LLC funds, thus a separate checking account should be maintained for the Limited Liability Company. If the Limited Liability Company needs money, additional shares or interests should be sold or the Limited Liability Company should borrow money. If money is borrowed, the money should be loaned to the Limited Liability Company based on a note. A note payable to the grantor of the funds should be signed by the Limited Liability Company Manager and a copy preserved with the records of the LLC.
On the subject of financial matters, if you contemplate that the Limited Liability Company will be purchasing a large capital item or exchange such an item for an interest in the LLC, then some attention should be given to the structure of any loans required. As a separate entity, the Limited Liability Company's loan write-offs ordinarily will flow through to its members as set out in the Agreement.
In order to validate the existence of the Limited Liability Company, proper formalities must be observed such as signing and dating appropriate documents and following the formality of acting through the entity when conducting business. The name of the Limited Liability Company is preserved in Delaware, but not in other states. If you will be operating in other states or internationally, the name should be recorded in the states where you will be operating and registered with the federal copyright office. Likewise, the Limited Liability Company is properly registered in Delaware, but may require additional filing if you are to engage in business in other states. An LLC is not for everyone and is not recognized in every state, but it does provide a viable alternative depending on the nature and location of your activity.
An LLC requires some thought as to its organization, but if properly structured an LLC allows you the opportunity to have the limited liability typically associated with a corporation while at the same time enabling you to be treated as a partner for federal tax purposes. The owners of an LLC are referred to as members. Members are obligated to the organization only to the extent of their contribution.
To summarize, the components of a limited liability company include:
- Certificate of Formation - A document filed in the office of the Secretary of Sate of Delaware setting out the name of the LLC, the registered agent and such other information as the members deem relevant. See 18 Del. C. Section 201.
- Members - similar to shareholders of a corporation, the members are the "owners" of the Limited Liability Company. See 18 Del. C. Section 101 (11).
- Managers - similar to the officers of a corporation, the managers manage the business and affairs of the Limited Liability Company. See 18 Del. C. Section 101 ( 10 ).
- Limited Liability Company Agreement - A writing similar to a partnership agreement or corporation by-laws which sets out in depth the rights, duties and obligations of members and managers are usually set forth in the LLC agreement. If the agreement is silent, the members manage the LLC. Generally, all members have equal rights but the rights of the members, like partners in a partnership, may be modified by the LLC agreement. More specifically, members may be divided into any number of classes or groups having such rights, powers and duties as set forth in the LLC agreement. All details concerning the appointment of managers and their powers are left to the LLC agreement. Like members, managers may be divided into classes or groups with specific powers.
Benefits of a Delaware Limited Liability Company
- No shareholder/member limit;
- No restrictions on classes of members;
- No general liability;
- Limited liability for members and managers;
- Taxable as a partnership for federal tax purposes;
- Flexibility of the management structure due to the fact that management is pursuant the LLC agreement;
- Limited liability of members and managers to third parties;
- A fixed annual tax without regard to size or number of members.
Why Form A Limited Liability Company?
To answer the question "Why form a Limited Liability Company?", let us look at the various alternatives available when forming a business entity. In establishing any sort of business, we want to optimize the operation of the entity by selecting the appropriate operating format. Alternatives that should be considered are the proprietorship, the partnership, the limited partnership, the corporation and the limited liability company.
- Proprietorship - The first alternative to a corporate format for your business enterprise is the proprietorship. Traditionally, an individual commences business with no formal organization. The only obligations upon the business are to obtain appropriate business licenses and make appropriate tax filings. The proprietor makes all decisions and all income or losses have a direct impact upon the proprietor. The owner is liable personally for all debts of or judgments against the business.
- Partnership - In order to spread the risk of commencing a business or to extend an operating business, a proprietor will often take a partner. Partnerships range from extremely informal verbal agreements to complex written documents setting forth all of the rights and obligations of the parties. The partners are the owners of the business and are treated as if they were the business for purposes of liability and tax obligations. The owners make all decisions. The operation of the business is uncomplicated until the business grows or there is a disagreement among the owners. The partners are liable individually for all debts of or judgments against the business.
- Limited Partnership - The limited partnership form of operation is a hybrid between corporations and a partnership. Most states have statutory requirements that must be carefully followed in order to establish a limited partnership. The partnership formation involves a general partner who will operate the business and make decisions, and limited partners who are insulated from unlimited liability and the management of the enterprise. This form of partnership is most frequently used where there is an attempt to convey tax benefit and limited liability for the limited partners.
- Corporation - Unlike the other forms that an operating entity might take, a corporation is an entity separate from its owners. It may help you to think of the corporation as a separate person. This concept of a separate person results in insulation of the actual owners of the corporation from liability for corporate debts or negligent acts of the corporation. The amount that a shareholder has at risk as a result of his stock ownership in a corporation, assuming a legitimate corporation and no shareholder fraud, is never more than the shareholders' investment in the stock. In creating a separate corporate person, we have also created a new taxpayer, subject to corporate income taxes.
- Limited Liability Company - the limited liability company is essentially a hybrid that is intended to allow the combination of the best features of partnerships and corporations. A properly structured limited liability company allows its members to be taxed as a partnership for federal tax purposes, while at the same time affording its members the limited liability typically found in corporations.