Tag Archives: organization

Forming Limited Liability Companies (LLC’s)

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The Limited Liability Company or LLC as it is better known has been one of the most popular business entity structures during the past 50 years. The LLC is the convenient hybrid of a partnership and a corporation and benefits form some of the most favorable aspects of both. LLCs limit the liability of their owners while giving them flexible management power and the ability to choose the business’s tax treatment. 

Unlike a general partnership, and more closely related to a corporation, the LLC must follow a series of rules for an effective formation, the failure to correctly follow these rules may prevent the attempted LLC from conducting business or protecting its owners from liability. 

An LLC is formed when articles of organization are filed with the Secretary of State (or if the articles so provide, the LLC will be formed on a later date no more than 90 days from the date of filing.) Articles of organization are functionally similar to a partnership’s articles of organization or a corporation’s articles of incorporation. An LLC has very limited power to conduct business before filing its articles of organization, except it may perform some limited prefiling organizational activities which might include some real estate transactions that will be assigned to the soon to be valid LLC. Despite the very limited exception, a soon-to-be-formed LLC generally may not incur debt prior to formation. However, the organizers of the LLC may incur debt on behalf of the soon-to-be-formed LLC and engage in other business, though they will be liable for any debts and liabilities incurred. After formation the LLC may through express agreement, assumption, or novation accept the liability of its organizers for the contracts and other liabilities incurred during its formation. 

Articles of Organization-

The LLC’s articles of organization must include fundamental information concerning the LLC, including the name of the LLC, the Purpose of the LLC, the name and address of the LLC’s registered agent and registered office, if it will be manager-managed then it must include a statement specifying such, the events or conditions that will result in the termination of the LLC, and the name and address of each organizer. The articles must be signed and filed by only one person, though that person does not need to be a member or manager of the LLC and may be an unnatural person like a partnership or LLC. In addition to the article of organization, the filer must submit a filing fee which differs from state to state. 

After filing but before actually conducting business, the LLC must have an operating agreement. An operating agreement is an agreement, written or oral, between all the members, or a written declaration by the sole member, that addresses the conduct of the business and affairs of the LLC and the rights, duties, and obligations of the members or managers. I have said it before but it bears repeating, an oral agreement may suffice but a written agreement may be wiser and can be required in some circumstances. Because operating agreements may be oral they seldom must be submitted along with or after filing paperwork, which means some states may not have a deadline for the adoption of an operating agreement or provide consequences for the failure to adopt an operating agreement. Practically speaking adoption of an operating agreement should happen simultaneously with filing.

Broad discretion is given as to what provisions will be included in an operating agreement. However, in the absence of an on-point clause or provision, state law acts as a gap filler and supplies default rules that apply to the LLC. These default rules are seldom advantageous to the members and may inhibit the intended business, so members should carefully review and address the issues covered by state default rules. 

Operating agreements often address many of the same issues that are covered in corporate bylaws. shareholder agreements, or partnership agreements. Because of the hybrid nature of LLCs and their flexibility, the form and contents of operating agreements may vary greatly depending on the specific facts and circumstances involved in the particular business venture. Despite the wide variation, an LLC’s operating agreement should address information or provisions relating to the members of the LLC including initial and additional capital contributions or loans; percentage/units/other measures of ownership interests; allocations of income and loss; tax treatment; distributions of cash at intervals or liquidation; business purpose; management rights and powers (including election or selection of managers, authority or restrictions of authority, meeting and related procedural requirements, indemnification; and transactions involving conflicts of interest); rights or restrictions on competing activities; accounting; rights or restrictions on new membership or transfers of interests; events of withdrawal of a member; dissolution and liquidation; amendment of the operating agreement; and other relevant organizational and operational issues. 

Operating agreements may be modified at any time by following the provisions provided in the original operating agreement or if none exist then by following the requirements of state law. Operating agreements are typically modified when there has been a substantial change in circumstances or business that was not anticipated by the original operating agreement so that the original operating agreement does not address the changed responsibilities, business operations, or property contributions. Generally, all the members should sign an amended operating agreement and the amendment should include language that indicates that it amends or modifies the original agreement. In the alternative, aka the less messy and prone to error solutions, the partners can execute a new operating agreement that includes language indicating it replaces the previous operating agreements and is the final and complete iteration of the operating agreement. 

Amending the Articles of Organization

Once filed the articles of organization must be amended in certain circumstances and may be amended in others. Amended articles are required within 60 days of a change from a member-managed to a manager-managed LLC (or vice-versa), after a change in the LLC’s name, or after a change in the dissolution date of the LLC. Articles of organization may otherwise be amended at any time and in any respect so long as they only reflect provisions that are contained in the LLC’s operating agreement. In the alternative, articles of organization may be amended by restating the original articles of the organization, without any additional amendments.

 As a final lingering piece of history, an LLC may be organized to conduct or promote any lawful business purpose (Some states require a statement of specific purpose or some iteration stating that the LLC is organized to conduct any lawful business.) When LLCs were first formed, and corporations for that matter, they could only receive the legal protections and benefits of their formation if they were formed to accomplish a specific purpose. 

The Basics: Simple Types of Business Organizations

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If you are anything like me, you might be confused about different forms of business entity. Law school students and attorneys frequently stumble when faced with a new or unfamiliar form of business structure, and with the frequency of changes in the law, this situation occurs more often than you might think. Business organizations or associations, depending on where you live, is an area of law that focuses on the rules involved in the formation and operation of different business types. Courses on this subject are taught in many law schools and it is a frequently tested subject on the bar. It is often overlooked by students in law school and by entrepreneurs who do not appreciate the importance of the subject.

To resolve some of that confusion this post will address four very simple types of business. This is by no means an exhaustive description and these businesses differ from state to state, however, these businesses are widely recognized.

As a brief introduction, there are two different ways to form a business. First, an individual or group of people can simply start doing business. Second, an individual or group of people can file documents with a government agency, typically the IRS and their state’s Secretary of State, to form a business. The first way is free, however, it does not protect the owners from common issues like liability, improper actions by employees, tax issues, etc. The second type requires a little more thought and a filing fee or two but allows greater protection because it lets the business owners set the rules of the business. This is a huge benefit because courts examining a business entity will often rely on old inflexible rules that may run contrary to what the business owners wanted or intended. Let’s jump into the four main groups shall we?

  1. Sole Proprietorship

The Sole Proprietorship is one of the simplest business organization. The sole requirement, (no pun intended) is that an individual begins doing business. This could be complicated web development, the opposite of what I do, or the individual may start selling things at the local flea market. The essential component is that they are the sole owner of the business and they are doing business. The IRS has a slightly different definition, but one that for all intents and purposes is the same. It reads: “A sole proprietor is someone who owns an unincorporated business by himself or herself.”

Sole proprietors are liable for almost everything. Because there is no separation between the owner and the business the owner is responsible for any violation of law, or harm that he or she causes. Individuals who sue the business may collect from the business and if the business doesn’t have enough money then the individuals can collect from the business owner. This means that business owner is also responsible for their employees, and are liable for the taxes and fees associated with those employees.

The sole proprietorship is very good for individuals who don’t want to go through the hassle of filing multiple tax returns. All of the profit and loss of the sole proprietorship is passed on to the business owner.

2. Partnership

Partnerships are the multi-person compliment to the sole proprietorship. A general partnership is formed when two or more people start a business together, so long as ownership is shared between them. However, people may form limited partnerships by agreeing to certain rules that govern the relationship between the partners. Ownership is split proportionate to the number of partners, so if there are two partners then ownership is 50/50.

In a general partnership every member is liable. This means that creditors, like the IRS or people who have sued the partnership, can collect from the assets of the partnership and if there is not enough money in the assets, they can then collect from the partners as well. To prevent this result a lot of partnerships choose to file as limited partnerships (lp) of limited liability partnerships (llp) because they can limit their liability to the assets of the partnership. Put simply, the partners will only lose what they have put in.

Partnerships pass their income to the partners. So the partnership does not pay any tax instead the partners pay their income tax on their portion of the partnership income. However, partnerships can choose to be taxed like corporations which means the partnership pays tax on what it has made and then the individual partners pay additional tax on what they are paid by the partnership.

3. LLC (Limited Liability Company)

The LLC is a fairly new business organization. Unlike the previous two, it has existed for the past 43 years. LLC stands for Limited Liability Company, if you mistakenly say corporation you will receive odd looks and a few eye rolls. The LLC is created by filing paperwork with the state. This differs from state to state however most states require that the business owners file with the state’s secretary of state. Along with basic information about the business including its purpose, name, and some contact information, the business must also have articles/certificate of organization, this is essentially the founding document.

LLCs limit the liability of the owners. The owners are usually liable up to the amount of the LLC’s assets. This is very useful especially for businesses that operate in riskier areas, where they are more likely to be sued.

LLCs may be taxed as a corporation or as a partnership, however, the default rule is that they will be taxed as partnerships. So, the LLC’s owners pay the taxes for the LLC through their personal income tax. The LLC’s profit passes through to the owners, is treated as a wage or salary.

4. Corporations

Corporations are well known and both hated and loved. People love to own stock of corporations but hate what corporations do. Corporations function similarly to an LLC. They are formed by filing specific paperwork. These documents include the article of incorporation (aka the founding document), Bylaws (the rules), and other agreements or documents as necessary. At the same time as the filing of the articles of incorporation with the Secretary of State, the corporation must sell its stock. Stock is ownership in the business. Stock is often referred to as shares or securities, and it represents a right to vote and be paid for that ownership.

The owners, or shareholders, of a corporation have limited liability. They cannot be required to pay more than the what they have already contributed to the company. For example, corporations like Purdue pharmaceutical have been sued repeatedly for their part in the opioid crisis and those companies have lost a lot of money. However, the creditors, or the people suing, are limited in the amount of money they can get, they cannot collect from the owners of the stock after they have exhausted all of the companies money.

Corporations are subject to double taxation. The corporation is taxed on its profits, and then the shareholders are taxed on the money they receive from the corporation as their share of those profits.

Conclusion:

Each of these business organizations has its own advantages and disadvantages. Sole Proprietorships give the owner absolute control over their business but they are liable for all debts or actions against the business. Partnerships allow a lot of control but are also liable for almost everything. LLCs limit liability but cost more to make and have limitations on the owners’ ability to control the business. Corporations provide a lot of liability protection however control is as centralized.