You should consider forming an LLC (limited liability
company) if you are concerned about personal exposure to
lawsuits arising from your business. For example, if you
decide to open a store-front business that deals directly with
the public, you may worry that your commercial liability
insurance won't fully protect your personal assets from
potential slip-and-fall lawsuits or claims by your suppliers
for unpaid bills. Running your business as an LLC may help you
sleep better, because it instantly gives you personal
protection against these and other potential claims against
your business.
Not all businesses can operate as LLCs, however. Businesses
in the banking, trust, and insurance industry, for example,
are typically prohibited from forming LLCs.
Should I choose
an LLC or an S corporation?
While the S corporation's special tax status eliminates
double taxation, it lacks the flexibility of an LLC in
allocating income to the owners.
An LLC may offer several classes of membership interests
while an S corporation may only have one class of stock.
Any number of individuals or entities may own interests in
an LLC. However, ownership interest in an S corporation is
limited to no more than 100 shareholders. Also, S corporations
cannot be owned by C corporations, other S corporations, many
trusts, LLCs, partnerships, or nonresident aliens. Also, LLCs
are allowed to have subsidiaries without restriction.
What is an LLC
Operating Agreement?
An LLC operating agreement allows you to structure your
financial and working relationships with your co-owners in a
way that suits your business. In your operating agreement, you
and your co-owners establish each owner's percentage of
ownership in the LLC, his or her share of profits (or losses),
his or her rights and responsibilities, and what will happen
to the business if one of you leaves.
Do I need to
have an Operating Agreement?
Although most states' LLC laws don't require a written
operating agreement, you shouldn't consider starting business
without one. Here's why an operating agreement is
necessary:
-
It helps to ensure that courts will respect your personal
liability protection by showing that you have been
conscientious about organizing your LLC.
-
It sets out rules that govern how profits will be split
up, how major business decisions will be made, and the
procedures for handling the departure and addition of
members.
-
It helps to avert misunderstandings between the owners
over finances and management.
- It keeps your LLC from being governed by the default
rules in your state's LLC laws, which might not be to your
benefit.
Must I hold LLC
meetings?
Although a corporation's failure to hold shareholder or
director meetings may subject the corporation to alter ego
liability, this is not the case for LLCs in many states. In
California, for example. an LLC's failure to hold meetings of
members or managers is not usually considered grounds for
imposing the alter ego doctrine where the LLC's Articles of
Organization or Operating Agreement do not expressly require
such meetings.
Exceptions to
Limited Liability
While LLC owners enjoy limited personal liability for many
of their business transactions, it is important to realize
that this protection is not absolute. This drawback is not
unique to LLCs, however -- the same exceptions apply to
corporations. An LLC owner can be held personally liable if he
or she:
- personally and directly injures someone
- personally guarantees a bank loan or a business debt on
which the LLC defaults
- fails to deposit taxes withheld from employees' wages
- intentionally does something fraudulent, illegal, or
clearly wrong-headed that causes harm to the company or to
someone else, or
- treats the LLC as an extension of his or her personal
affairs, rather than as a separate legal entity.
This last exception is the most important. In some
circumstances, a court might say that the LLC doesn't really
exist and find that its owners are really doing business as
individuals, who are personally liable for their acts. To keep
this from happening, make sure you and your co-owners:
-
Act fairly and legally. Do not conceal or
misrepresent material facts or the state of your finances to
vendors, creditors, or other outsiders.
-
Fund your LLC adequately. Invest enough cash into
the business so that your LLC can meet foreseeable expenses
and liabilities.
-
Keep LLC and personal business separate. Get a
federal employer identification number, open up a
business-only checking account, and keep your personal
finances out of your LLC accounting books.
-
Create an operating agreement. Having a formal
written operating agreement lends credibility to your LLC's
separate existence.
A good liability insurance policy can shield your personal
assets when limited liability protection does not. For
instance, if you are a massage therapist and you accidentally
injure a client's back, your liability insurance policy should
cover you. Insurance can also protect your personal assets in
the event that your limited liability status is ignored by a
court.
In addition to protecting your personal assets in such
situations, insurance can protect your corporate assets from
lawsuits and claims. Be aware, however, that commercial
insurance usually does not protect personal or corporate
assets from unpaid business debts, whether or not they're
personally guaranteed.
