You’ve heard them mentioned before. You may even have formed one or had one formed for you. But what exactly is a Limited Liability Company (LLC)?
Before diving into a high-level discussion of LLCs, let me preface my remarks by saying LLCs are creatures of state laws. In other words, the specifics of forming LLCs and the nuances of how they operate can vary from state to state. So, whatever I mention in this article is intended to give you a high-level understanding of the primary purposes of LLCs and is not intended as a substitute for speaking to a professional in your state.
An LLC is a type of private business entity that is formed according to the laws and regulations adopted pursuant to state law. For example, the regulations in the State of Delaware, which often is regarded as a model for business and corporate laws and structures, defines an LLC this way:
A limited liability company (LLC) combines certain characteristics of both a corporation and a partnership or sole proprietorship (depend- ing on the number of owners.) Members of a limited liability company are given the same advantage of “limited liability” as shareholders in a corporation but are generally taxed only at the member level like a partner in a partnership. LLC members are the owners of the LLC as much as shareholders are the owners of a corporation or partners are the owners of a partnership.
And Delaware classifies an LLC for come tax purposes thusly:
A Limited Liability Company do- ing business in Delaware is classified as a partnership for Delaware income tax purposes, unless it has otherwise been classified for federal income tax purposes.
An LLC is always classified in the same manner for Delaware income tax as it is for federal income tax purposes.
Inherent in its name, an LLC “limits liability” to the owners or members of the LLC. Generally, an LLC owner’s personal liability for LLC matters is limited to the amount of the owner’s investment into the LLC. This can be a significant advantage for small businesses and individuals who wish to avoid exposing their personal assets to claims arising from the business.
For example, consider a retired farmer, one who owns considerable assets (a large-acreage farm, some stocks and bonds, etc.) and wants to open a taxidermy shop or studio as a part-time job to supplement income.
Let’s think about two scenarios. In one example, the retired farmer does not form an entity (such as an LLC or corporation) and instead operates a studio as a sole proprietorship. In a different example, our farmer operates a studio using a single-member LLC.
If our farmer operates the studio as a sole proprietorship and incurs debt (e.g., purchases supplies on account) or the studio is alleged to have performed bad work, damaged property, or the like, it is possible that all of the farmer’s assets—not just the assets involved in the studio— will be exposed to claims. On the other hand, if the farmer operated the studio as an LLC, only the studio’s assets—none of the farmer’s personal assets—would be at risk. Of course, there are exceptions—using an entity will not shield the farmer for committing fraud or other intentional wrongs—but as a general matter an LLC is treated as its own legal person and would help protect the farmer’s personal assets from the reach of studio claimants.
LLCs are typically governed by an “operating agreement,” though in some states one may not be required. Like most legal agreements, the length and complexity of an operating agreement vary greatly. Similarly, though a “single member” LLC is the most common—especially, for individuals looking to protect their personal assets. Many LLCs consist of multiple “members.” So, an operating agreement with multiple members usually includes additional provisions or considerations, such as defining responsibilities and delegation or succession.
One particular provision or aspect of a multiple-member LLC is the designation of a “managing” director or member. In such instances, one of the members is designated as being responsible for certain managerial or administrative tasks, depending upon the goals and desires of the other members and purpose of the LLC. Therefore, when setting up an LLC, it is important to discuss such issues with your professional representatives and consultants as “one size fits all” agreements can present future issues.
Another topic that often arises when talking about LLCs, is the issue of taxes. For example, some corporations require the filing of separate tax returns, an LLC is typically taxed more like an individual or partnership and is sometimes referred to as a “pass through” entity, which does not require the filing of separate tax returns, just a supplemental form or schedule.
Choosing the right form for operating a business requires a deep conversation with your financial and legal advisor. Understanding, the pros and cons of various business entities is worth knowing.
Mike Oropallo is a partner and co-team leader of the Outdoor & Wildlife Team at Barclay Damon LLP. He has over 30 years of complex civil-trial experience, focusing on archery, the outdoor industry, and wildlife. He handles patent, trade- mark, and copyright matters for a wide variety of outdoor and archery clients.