Forming a Limited Liability Company (LLC)
For those that followed our article last week detailing the Best Practices for Transferring Rental Properties into an LLC, this article will answer questions for those wondering about the actual process of forming a Limited Liability Company (LLC).
Q: As a small-business owner, what’s the importance of forming an LLC? And what are the most important things you want to prepare a client for?
That’s a great question. A Limited Liability Company provides greater flexibility, it’s one of the reasons why they’re so helpful for small businesses. As it’s in the name, LLCs provide owners with limited liability as it relates to their company. They can also help businesses set up a good foundation – especially with operating agreements – you can head off a lot of issues that you may not foresee. Though when you have a good operating agreement – especially with a multi-member LLC – it will determine the roles and responsibilities of all parties. LLCs are a good tool for any business, especially if you do not want to be held personally responsible for lawsuits against the company.
There are also some tax advantages to it, like pass-through taxation. It provides a lot of flexibility with low maintenance in terms of paper filing per year, it’s very cost-effective and helps organize your business.
Q: Could you enlighten us on the importance of an Operating Agreement?
Of course, the operating agreement is very important – not so important if you’re talking about a single-member LLC, because you’re the sole member. But if you’re looking to add somebody into the business, or you’re looking to split different responsibilities with the business – for example, one member puts up capital funds, another is putting up labor, and another is putting up the property – the operating agreement determines the terms of everyone’s interest in the business. This and what happens if the business dissolves are all determined through the operating agreement.
Q: You often hear the term Articles of Incorporation, where does that fit into the Operating Agreement? Or the LLC for that matter?
With LLCs, these articles are called the “Articles of Organization”. These are the documents that you file with LARA – the state licensing and regulatory agency. Usually, it can be as basic as you want. But a lot of times it will ask who the members are, what their interests are, and some sort of boilerplate language. The real meat of the issues will be fleshed out in the operating agreement itself. But the Articles of Organization are one of the necessary pieces.
Q: From your perspective, is it better to meet an attorney on these matters first or write them on a napkin and flesh it out later?
We see this all the time. Some clients think they have a good business relationship with somebody, maybe someone they’ve been dealing with for over 10 years. With that history, they think they can write a business agreement on a napkin and hash it out later. It’s never a good idea to do that. In many cases, even if you have a great business relationship, things tend to sour. Many people don’t see it coming or want to think about it happening, for that matter. This is why it’s crucial to meet with an attorney first to ensure all parties are covered and to have that third-party element present.
Q: I assume the old expression of being penny wise and pound foolish comes into play if you’re a business owner and not using a lawyer, is that correct?
Definitely, we see a lot of businesses that want to be frugal, and that’s fine. But you really can’t cut corners when it comes to legal costs. Sometimes you need to pay that minor legal fee to avoid an exorbitant lawsuit later. So, it’s very helpful to have that help upfront.