This post is part of Priori’s new blog series “From Our Network,” where we feature lawyers in our network discussing important issues small businesses face. In today’s post, corporate and intellectual property lawyer Mark Koffsky breaks down how an LLC works and explains best practices to ensure that you can actually reap the benefit of your limited liability status.
Limited liability is crucial when running a business—in fact, it is the most important thing a business owner can do to protect himself or herself from personal liability. If your business fails, then it fails and that’s a bad thing. But if your business fails and you neglected to properly establish a limited liability entity for your business, then you can lose everything: your house, your car, your personal bank account. That’s a disaster.
So how do you protect yourself? The entity that is most often appropriate for startups and small businesses is the limited liability company (LLC). First brought to the US by Wyoming in 1977, LLCs are now available in all 50 states. LLCs are a flexible tool that can provide the best of both worlds: limited liability for the owners (members) of the LLC and “pass-through” taxation that allows the members to pay the taxes on earnings of the LLC on their personal returns.
In New York, LLCs are established by filing Articles of Organization with the Department of State. The Articles usually include a few paragraphs reciting the name of the LLC, the county of establishment and an address where legal papers can be served. That is a public document. Once created, the members then enter into an Operating Agreement that governs how the LLC will be run. This document is not filed with the Secretary of State and can remain private. The Operating Agreement defines how the LLC will be run, how profits and losses will be allocated, and how new members may be admitted to the LLC or current members expelled from the LLC.
The good news is that LLCs have far fewer ongoing formalities than corporations, which require by-laws, share certificates, annual shareholder meetings and periodic board meetings with written minutes. Nonetheless, even for small LLCs, following best practices in LLC governance is crucial to maintaining its limited liability status.
Here are some suggested tips:
- Enter into an Operating Agreement as soon as possible after establishing the LLC. Even a single-owner LLC should have one.
- Never co-mingle LLC funds and personal funds. Establish a business account for your LLC immediately upon formation and use that to pay all business expenses. If a business owner (or employee) spends personal funds on LLC business, the owner or employee should invoice the LLC and be reimbursed from the business account.
- Establish a corporate minute book where all corporate documents are kept in one place. No need to buy anything fancy from a stationery store; a simple binder (or electronic folder) is fine. In New York, there is also no need to buy an expensive corporate seal.
- For initial LLC expenses (such as filing fees and legal work) where the use of personal funds by a founder is necessary because there is no LLC yet, the founder should keep written records of the amounts spent. Then once the LLC is created and the account is funded, the founder can submit an invoice detailing the expenses and be reimbursed from the LLC business account. A resolution of the LLC should be prepared stating that these initial expenses were incurred on behalf of, and were in the best interest of, the LLC.
- Any financial contributions by the members to the LLC or financial distributions by the LLC to its members should be documented by the LLC. A simple resolution of the LLC memorializing the contribution or distribution should be prepared for each transaction.
- Finally, never sign any document related to the LLC in your personal capacity. You should always be signing documents as an officer of the LLC. For example, always sign on behalf of XYZ, LLC as Jane Doe, President of XYZ, LLC and never as Jane Doe.
When used properly, LLCs can be a key tool in protecting your personal assets from business liabilities while providing favorable tax treatment. That’s a win-win scenario every business owner should embrace.
Questions about LLCs or other types of corporate form? Curious about the elusive corporate veil? If so, submit your questions in the comments section below, twitter, facebook or to hello@priorilegal.com before Wednesday 11/20 at 11:59pm and Mark will pick 1-2 to answer. We will post his answers to the blog later this week.
