Tag Archives: ownership

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. 

Buy/Sell Agreements

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The buy/sell agreement may not be familiar to individuals who have just started their business or are working on their own however, these agreements are an important way of controlling the outcome of the business. The basics of the agreement are straightforward, the agreement sets out how an owners share of the business may be assigned or transferred if the owner dies or wants to leave the business. The agreement serves to smooth the changes that might occur if one of the four D’s happen. In the case of death, divorce, dissolution, or disaster, the agreement lays out how the business ownership will work moving forward.

There are a few different ways that these agreements may be setup. First, the agreement may require that the remaining owners purchase the shares of the departing owner. Second, the business may purchase the ownership interest of the departing owners, this happens more often with closely held corporations than partnerships or LLC’s. Depending on what the owners of the business want, they may opt for a mix of the two options.

It is important to know that there are several reasons that a business may need a buy/sell agreement even if things are going well and there doesn’t seem to be any reason to use one. One of the big reasons is that it allows the owners to restrict who may become an owner. It is very common that small business owners are concerned about the possibility that a new owner will push the original owner out of control. When an owner dies, a restriction on who becomes the new owner can prevent the deceased owner’s estate from selling, transferring or otherwise controlling the business when the estate does not have the same focus on the success of the business that an original owner may have had. Additionally, the agreement creates an impartial method of determining the value of the departing owners share of the business. Instead of allowing the remaining owners and departing owner from arguing and possibly destroying the business, a valuation method creates the separation necessary to conduct an impartial sale of the departing owners share or another transfer free of the concerns that might hinder or destroy a sale.

It is important to remember that along with many other business transactions, a buy/sell agreement must be funded by the owners or the business. Problems frequently pop up where an agreement states that the business or an owner will buy the shares of a departing owner yet the buyer does not have the money available to make the purpose. This may result in the becoming stale and eventually unenforceable. Or the buyer may be saddled with debt that makes them insolvent, which in turn kills the business and forces the individual owner or business into bankruptcy. To avoid this problem companies often rely on insurance policies in the case of the death or disability of an owner, or they use cash proceeds and or borrowed money to buy the departing owner’s share.