Bite-Sized Bits of Knowledge

Hi. This is Barry Haimo. Thanks for tuning in to another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time. Today, we’re talking about limited liability companies, or LLCs. 

In Florida, they’re really easy to file. You file articles of organization with the Department of State and that will create you a legal entity. They require one shareholder, which is called a member, or can have multiple shareholders or multiple members. I’m going to use the term interchangeably, but in an LLC they’re members, not shareholders. In terms of raising capital, they’re just like a corporation where you can issue new units or new membership interests, or you can issue debt to raise capital. They will last in perpetuity unless the operating agreement says otherwise.

Default rules may surprise you. So you want to control those rules. You can set the rules. The law allows that. You can almost change every rule, with few exceptions. Operationally, there are some formalities you got to comply with, but there’s less than a corporation. 

From a management perspective, it has two ways it could be done, okay? The first way can be modeled after the corporation where it was shareholders electing directors who appoint officers. In LLCs, you can have your members elect managers, who either run the business or elect officers. It’s a bit different because you have members electing managers. 

So managers are the highest-authority person in an LLC, believe it or not. Sounds counterintuitive, but managers are the boss. The directors, so to speak. And they can appoint officers to carry out the vision and execute the plan, okay? So that’s more of a centralized management mirroring a corporation. 

In contrast, you can also have an LLC that’s treated as member-managed instead of manager-managed. It could be member-managed, and that means that all the members are also almost managers. They’re also empowered to act on behalf of the company like an agent. Think of it more as a general partnership where all the partners can run around and buy in the company as agents of the business. I would say that nine out of ten times when we do these, we never do it that way, and there’s a lot of reasons why. I’m not going to get into it.

I like the centralized management structure of a corporation in an LLC. It’s just my preference for being around these a long time. I know them very well. In terms of liability exposure, they’re like corporations in the sense that the members have limited liability up to their investment.

Again, I want to mention that there’s two kinds of creditors. There’s creditors of the business. We have PI claims, we have contract issues, employment law issues, I mean taxes – you name it. There could be corporate or business liabilities that are the businesses problem, and not the members. But in contrast, there could also be members who have a personal matter where somebody gets a judgment against a member where that judgment holder is looking to satisfy that judgment with their assets, the member’s assets. 

And that business – this LLC – represents an asset, just like a bank account or a car. The treatment between LLCs and corporations in this respect is very different, and it’s far more favorable to be an LLC. As a result, if you structure everything properly, you can really protect your interests better with an LLC than a corporation. 

Taxation wise, there’s four ways that an LLC can be taxed. Four ways. Single member LLCs are by default taxed as a disregarded entity, like a sole proprietor. The IRS doesn’t even know you have a company. They don’t care. It’s taxed as if you’re doing business in your name. 

If you have two or more members, the default rule is you’re taxed as a general partnership. That’s the default rule. Your tax is a general partnership. It’s a flow-through. You file a 1065, every partner gets their K1, and that could be ideal. 

The third way is you can elect to be treated as a C corp, just like we’ve talked about. You can be elected to be taxed as a C corp. And fourth, you can elect to be taxed as an S corporation. An LLC, yes, can be taxed as an S corporation. Of course, if you make these elections, you have to honor the terms of keeping the elections or you lose them. So LLCs are very flexible when it comes to taxation in terms of transferring interest. Just like corporations, you can rely on the default rules of Chapter 605, or you can set the rules in your operating agreement.

The same issues apply. Do you want to be partners with spouses, creditors, heirs, et cetera? There’s a lot of issues that need to be fleshed out, and the default rules in the statute may not be desirable. So again, read Chapter 605 tonight before you go to bed and see if it makes sense for you. Otherwise you need to do an operating agreement.

I cannot stress it enough. Allocations of available cash are depending on your taxable entity that you’ve chosen. If it’s a partnership, it’s very flexible. You can reallocate profits and losses and distributions any way you want as long as you’re honoring the economic terms. So as long as there’s what’s called a substantial economic effect. And that the terms of your agreement and the economics of your business are the same. In a partnership, whether it’s a general partnership or an LLC, you can do that, very flexible, which is great for investors. Investors like that. If you do a C corp or an S corp, you have the same limitations that we already talked about. So it really depends on what you’re doing for tax purposes. 

Dissolving it is the same thing as a corporation. It’s complex. There’s a lot of rules. You got to do it right or you’re going to be in trouble. 

So LLCs really are, I think, the right decision for most formations. Again, if you want to scale big and you want to go public, you really can’t be an LLC, but you can be an S corp. You can be a small business. You can be a big business, but you just have so many options. It’s so flexible with an LLC that really that’s kind of the most common one for a reason. 

But again, there’s so much that goes into this. You really have to get the holistic counsel we’ve been telling you about. Do your operating agreements, understand the terms of how you’re doing your business, and make sure that everything is – your “i”s are dotted, and your “t”s are crossed. And we’re going to get into a lot of other things about this stuff later. But suffice to say that our recommendation is typically an LLC, but it has to be structured properly.

And so, again, I want to remind you to download our free Business Entity Comparison Chart and our free Business Planning Stress Test. The links are below in the description. And I want to thank you for stopping by and stay tuned for more.