What Is an LLC? An Introduction to Limited Liability Companies
LLCs are relatively new business entities. They take the best of corporations and partnerships and merge them into one awesome hybrid entity. They have tremendous flexibility in a variety of important ways, which makes them the right choice in many circumstances.
For example, they can elect to be taxed in four different ways. LLCs taxed as a partnership can allocate profits and losses and distributions any way you want (provided it has substantial economic effect). Additionally, with few exceptions, you can modify most of the governing laws on LLCs, and they are less burdensome than corporations and less expensive than other entities to maintain. Finally, they can be used in estate planning to mirror limited partnerships and have important asset protection benefits if structured properly.
Is an LLC right for you? What else should you know about this useful business structure?
Understanding the Basics of Limited Liability Companies
Before you decide to form an LLC for yourself, there are certain basic things that you should know.
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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’ve got to comply with, but there’s less than a corporation.
From a management perspective, it has two ways it can 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 from 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, taxes issues – you name it.
There could be corporate or business liabilities that are the business’s 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. You’re taxed as 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. 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.
Those are the basics, and as mentioned in the video, structuring your business as an LLC is a strong choice for many people.
Where do you begin if you are going to set up your business using this structure?
The Limited Liability Company (LLC) Operating Agreement
One of the first things you need to set up an LLC is a well-drafted and crafted operating agreement. Ideally, this document should be extremely comprehensive and cover management, operation, tax and transfers.
In particular, it will address how the company is managed and by whom it is managed. It will set forth members’ (shareholders) rights and obligations. It also substantiates the type of taxation of the entity; mainly, partnership tax treatment as a flow-through entity, S-corporation, C-corporation, or disregarded entity.
A strong operating agreement also helps to maximize asset protection of the partners’ interests, and may include buy-sell provisions, transfer rights, rights of first refusal, and no assignment and alienation clauses. It should cover compensation, allocation of profit and losses for both tax and accounting purposes, and distributions of profits and losses.
In other words, it’s the most important document relating to your company.
What Happens If Your LLC Doesn’t Have an Operating Agreement?
If you fail to execute an operating agreement, Chapter 608 of the Florida statutes, will govern how your business works with respect to all of the above issues.
It’s not necessarily fatal not to have an operating agreement. The statute offers a simple but inadequate solution. However, it is insufficient to protect your company and your partners, and to ensure your objectives are accomplished.
As a brief example, the statute does not adequately provide for when partners’ allocation of profit and loss (P/L) deviates from their contributions to the company – or even each partner’s membership interest. Sometimes partners work out a deal to make the partnership work, which is a flexibility offered by LLCs.
Still, in this case and in a lot of other important cases, the statute does not cut it.
What’s the Most Important Part of Your LLC Operating Agreement?
This will sound like hyperbole, but everything in the operating agreement is important.
Management is no exception, as the agreement generally provides for the framework for how the company will be managed during its lifetime. The agreement will generally designate that the company is member (partner) managed or manager managed. These are like a board of directors of a corporation, with which you’re probably already familiar.
The operating agreement covers voting and quorum at regular and special meetings, during some of which the partners appoint one or more members or managers to serve in such capacity. It provides for electing new management, appointing officers for whom management may delegate responsibilities, and includes procedures for removal and vacancies of management. It may even outline each partner’s role and responsibility.
Unsurprisingly, management operates the company, so the operating agreement enumerates what powers it has to do so, including limiting each particular member or manager’s authority if necessary.
The agreement also covers how each partner will be compensated for their contribution to the company, which may include money, real property, personal property, connections, time, or energy. It may or may not be equitable compensation. If it is equity, it may or may not vest immediately. The statute does not enter the world of deferred compensation for key personnel.
Another important consideration that the agreement covers is how ownership interests are treated upon death and disability, as well as when an owner simply wants to exit the partnership. This becomes critical when a partner wishes to sell his or her interest in the company to a third party (transferability).
Consider factors such as the identity of the third party, price, timing, and how this will all play a part in the overall operation of the company. Would you want to be in business with your partner’s wife – or worse, a stranger?
Lastly, the operating agreement should cover indemnification as well as all pertinent covenants, which may include noncompete, solicitation, and confidentiality.
Of course, this is merely a superficial overview of the contents of a good operating agreement. What’s more important than the actual agreement is the time taken by the partners and the company’s attorney to flesh out all the foreseeable and unforeseeable issues now – before things get emotionally heated.
One LLC Pitfall to Avoid: Beware the Single-Member Limited Liability Company
Everyone that forms a business entity to limit their personal liability does so to separate themselves from creditors of the business, or “inside creditors”. Unfortunately, most people fail to realize that a creditor of an owner (known as a “member”) of a single-member LLC – such as yourself – can force you to sell your business, or foreclose your interest, to satisfy a judgment. And there’s little you can do about it. Period.
Here’s an excerpt of Florida’s pertinent statutory language (emphasis added):
“608.433 Right of assignee to become member.—
(6) In the case of a limited liability company having only one member, if a judgment creditor of a member or member’s assignee establishes to the satisfaction of a court of competent jurisdiction that distributions under a charging order will not satisfy the judgment within a reasonable time, a charging order is not the sole and exclusive remedy by which the judgment creditor may satisfy the judgment against a judgment debtor who is the sole member of a limited liability company or the assignee of the sole member, and upon such showing, the court may order the sale of that interest in the limited liability company pursuant to a foreclosure sale. A judgment creditor may make a showing to the court that distributions under a charging order will not satisfy the judgment within a reasonable time at any time after the entry of the judgment and may do so at the same time that the judgment creditor applies for the entry of a charging order.
(7) In the case of a limited liability company having only one member, if the court orders foreclosure sale of a judgment debtor’s interest in the limited liability company or of a charging order lien against the sole member of the limited liability company pursuant to subsection (6):
(a) The purchaser at the court-ordered foreclosure sale obtains the member’s entire limited liability company interest, not merely the rights of an assignee;
(b) The purchaser at the sale becomes the member of the limited liability company; and
(c) The person whose limited liability company interest is sold pursuant to the foreclosure sale or is the subject of the foreclosed charging order ceases to be a member of the limited liability company.”
So What’s The Solution?
You take advantage of assets that are exempt from creditors. You can also structure your company as a multi-member LLC, which enjoys considerably more asset protection benefits.
Additionally, I recommend not relying on Florida’s statute and investing in a strong operating agreement to ensure that you and your partners’ rights and obligations are clearly expressed. I cannot overstress the importance of doing this right in the beginning. The statute is merely meant to be a foundation for the rights, responsibilities, and obligations of the members of the entity.
Want help setting up your LLC the right way – or figuring out if an LLC is even the right way for you to go? Get in touch today to get started!
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Originally published 12/09/2021. Updated 01/21/2025.
Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose®
Email: barry@haimolaw.com
YouTube: http://www.youtube.com/user/haimolawtv
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