In most cases using a Limited Liability Company (LLC) is a thoughtful step, whether you are investing in your own business activities, real estate or side hustle.
Limited liability.
Important words, for sure. The owner of an LLC, called a Member, is shielded from personal liability for acts of the LLC and its other members. Creditors seeking to collect amounts owed by the LLC cannot pursue the personal assets (house, savings accounts, etc.) of the LLC Members to pay business debts.
There are exceptions, for sure. For example, if the Member signs a personal guaranty agreeing to pay the LLC’s obligation (such as a Lease guaranty), or if the Member commits a fraud in the course of dealings with another. And, in some instances, a federal or state statute may create a potentional personal liability for the Member (think about certain wage and hour responsibilities to employees or environmental liabilities under the environmental protection laws).
But in the main, the limited liability “umbrella” as it is called will shield the LLC Member in much the same way that the corporate veil of liability protection applies to a shareholder.
Flexible Management Structure.
A positive aspect of utilizing an LLC that is specific to this type of business entity is flexibility.
The LLC Members have a variety of options for the management structure and they can usually be quite creative. Control over LLC business operations ultimately rests with the Members. But the LLC Operating Agreement can be developed with the cooperation of your LLC Attorney to provide that the day-to-day Company activities will be controlled by a Manager.
Think of the Operating Agreement in the same way that the ByLaws of a corporation identify and define its business operations.
An LLC can be managed by Members or non-Members; by persons or by other business entities. Whether you have a few owners wanting to run the LLC’s business together, or many owners involved in the LLC operation, the flexibility to set up the LLC management is a plus.
This is why the LLC structure is sometimes used for family businesses, where the parents look to maintaining management control and provide financial participation to the children, as Members. Management control and transfer of Member Interests to the next generation can be used to assist in a variety of issues that are often unrelated to the LLC — from tax planning, estate planning, easing new family members into the business activities, and more.
Creative Approaches To Financing And Ownership, Including Ownership Transfer.
The ownership interest of an LLC Member (called the Member Interest) has two broad aspects, and they can be separated in full or in part. The Member’s financial rights (requirements to supply capital for operations and the right to receive distributions from the LLC activities, for example) are able to be separated from the second aspect of the Member’s Interest — the interest in management rights and participation in Company activities.
A Member’s financial rights, including the right to participate in profits and losses and to receive distributions can be designed to work as the Members decide and as they provide in the Operating Agreement. Will only one Member be providing the most substantial part of the financing for the business? Depending upon the circumstances, this Member may receive a repayment of some of their funding before other Members receive distributions. Perhaps, as well, this Member will not participate in making decisions about the day-to-day activities of the Company. The LLC should be tailored to the needs and realities of the business and owners.
A Member’s Interest in the LLC is personal property of the Member and the LLC Act in Illinois provides that those rights may be transferred without restriction.
But it is beneficial for the new LLC Members to know that the Operating Agreement may include restrictions on how a Member’s Interest may be transferred (sold or gifted) to another person. Some of the requirements under the LLC Act, like the transfer of an ownership interest, can be tweaked. So there can be a right of first refusal built into the LLC documentation, requiring the Member to first offer the ownership interest for sale to other Members before selling or gifting the Member Interest to another person. Likewise, the transferee of the Member’s Interest, depending upon the circumstances, may be restricted from participating in the LLC business activities and may only become a financial interest Member.
These concepts can be used to create important limitations in the event that a Member is sued or has to file for bankruptcy. We never hope that this comes to pass, but if it does and if the Members have planned properly, there will be useful limitations on what a creditor or bankruptcy trustee can do. And that helps the business to avoid an unfortunate situation.
Starting a business with others without using an LLC, by comparison, leaves the partners exposed in many ways: Each partner in a general partnership is personally liable for the debts of the partnership. Therefore, the law provides that the partner’s personal assets can indeed be reached by partnership creditors. Ouch! In the partnership scenario, each partner has the right to participate in the business operations, and the right to receive a ratable share of profits and losses (regardless whether the partner’s day-to-day participation may be more or less than other partners). And each partner has an equal right to control the partnership business by their vote.
We can see how the LLC protects the participant’s personal assets from LLC debts. And using the partnership example we can also see how the LLC Operating Agreement can be designed to refine and define each Member’s participation interest in the business. So information flow to some Members may be tailored to the specific circumstances, decision-making by some Members may be limited to significant decisions (such as a sale of the business or substantially all of the business assets, or the hiring of highly paid managers or officers), and participation may be expanded or limited in other ways. Flexibility is key.
Transparency Of Members’ Outside Interests & Activities.
The participation by Members can be specified in the Operating Agreement so that some of the Member’s own activities will be clearly described and transparent. Imagine that one Member is involved in other activities (for instance, a software developer client who was recently becoming involved with one of my client LLCs), and that Member wants to be certain that other participants in the LLC business do not have a claim to her separate development and app creation activities for others who are not clients of the LLC.
Another real life client example from our office real estate representation archives, is the use of the Operating Agreement to ensure that a Member’s outside activities were clearly her own. The Member, who is involved in other real estate development opportunities (she is an active real estate broker who frequently gets leads for new properties and new development opportunities) wanted the new LLC Operating Agreement to clearly state her understanding that she did not have to share all of her future opportunities and listings outside of the newly created real estate development with other Members or the LLC.
Pass-Through Taxation.
An LLC entity can be created so that it is effectively a disregarded entity for tax purposes, sometimes called a “pass-through” tax entity. This means that LLC gains, losses, income, deductions and credits can flow-through to the Members and be reported on their personal income tax returns. Taxes can therefore be paid at the Member’s individual tax rate. In this scenario, the LLC is not subject to being taxed at the corporate level like a regular “C” corporation.
Other Benefits.
There are other benefits of using an LLC, even if you are the only Member at the start. Talk with your LLC Attorney to understand how an LLC works, how it can benefit you and your business, and whether there are any downsides that you should consider. And be thoughtful and do your homework — LegalZoom and similar on-line LLC creation tools will not explore all of these considerations in the same way that an LLC Attorney will do.
Attorney Marc Sherman is available to review the creation and use of the LLC with you. Reach out to schedule a time to discuss: https://mshermanlaw.com/contact/
