The ABCs of LLCs: 10 Things to Know Before Setting Up a Limited Liability Company
When starting a business, deciding on the appropriate business entity structure is one of your first decisions. Most of the time, clients ask us about forming a limited liability company (an “LLC”), but often they do not understand the pros and cons of this structure. Moreover, if you have an LLC that was formed before October 2013, you need to be aware of changes in the law since then.
One of the newest business entity structures, the Limited Liability Company is a hybrid of a partnership-style structure and a corporation. It offers tax filing flexibility like a partnership, but also offers protection against liability similar to that of a corporation. But there’s more to it than that. Here are ten things we think you should know about Limited Liability Companies:
- An LLC is not a corporation. The terminology is completely different. There are no shares, no shareholders, and no Bylaws or Shareholders’ Agreements. There are “units” representing the percentage of each member’s respective ownership interest in the LLC, and an Operating Agreement that explains the purpose and operations of the company. The biggest difference is that all operational authority vests in the managers of the company, not in officers and/or a board of directors. The managers of an LLC have broad discretion in how they run the business of the company.
- An LLC can be taxed as a pass-through or as an S-Corp. It’s a simple matter of electing with the IRS to be taxed one way versus the other. The IRS does not have a separate classification for LLCs, and so it simply treats them as a sole proprietorships or partnerships (e.g. as a “pass-through” entity) unless the LLC elects to be treated as a corporation for tax purposes. It’s as simple as filing the right form with the IRS.
- “Limited liability” doesn’t mean “no liability.” Many clients think that setting up an LLC means that the members can avoid all liability for the actions of the business. Not so. The members will be liable for written obligations to make capital contributions, meaning that they may be personally liable for debts of the business if they fail to make such contributions. Members can be liable for contractual obligations incurred prior to setting up the LLC. And of course, a member always is personally liable for their own negligence or intentional actions.
- Layering entities doesn’t necessarily give you extra protection. Creating multiple entity layers (e.g. having a business operating under one LLC that is owned by another entity) does not give extra insulation to the ultimate owners of the company. Courts have at times expanded liability for the child LLC to the managers and members of the parent entity.
- There’s no more “managing members” designation. As of 2014, there is no separate distinction of “managing member” for a member of an LLC who is also the manager.There are manager-managed LLCs where the managers are not required to be a member of the LLC, and there are member-managed LLCs where its members are the managers of the LLC.
- Managers owe a fiduciary duty to the members of the LLC. Before 2014, a manager’s liability to the members was constrained to accounting, no self-dealing, and non-competition. Since the adoption of the Florida Revised Limited Liability Company Act (the “Revised Act”), however, the fiduciary role of the LLC manager has been expanded to include a general duty of loyalty.
- Florida law provides seventeen (17) non-waivable provisions. With the adoption of the Revised Act, the number of “nonwaivable operating agreement provisions” has increased from six to seventeen provisions that will not be enforced even if they are written into the LLC’s operating agreement. That means that most pre-2014 Operating Agreements are unenforceable as written.
- No Operating Agreement, no LLC. Yes, Florida Statutes Chapter 605 provides “gap fillers” that will substitute for an Operating Agreement but that’s really not the way the law is intended to work. LLCs are creatures of contract, meaning that without an Operating Agreement, there really is no agreement among the members and therefore no structure. The “operating agreement” definition in the Revised Act provides that in addition to written or oral agreements, an operating agreement may be in other forms, such as “implied, in a record, or in any combination thereof.” Better to get it in writing.
- No “shelf” companies in Florida. A shelf company is an inactive LLC that was created and left with no activity for a period of time so that it can be sold to someone who wants to own an LLC without the hassle of setting one up. Florida considered whether to allow shelf companies and nixed the idea. You must have at least one member in an LLC, and it is contemplated that they will be going concerns.
- Dissociation does not relieve a member from liability. If a member dissociates (leaves), that member may still be liable for certain obligations to the other members or to creditors. The dissociated member has no right to participate in the management of the LLC, but may still receive distributions until their membership interest is actually transferred to someone else.