The attorneys at GRIFFITH LAW GROUP form limited liability companies (LLC) more often than we form any other entity, because of the flexibility afforded by the LLC. An LLC is not always the best entity choice for our clients, and there are limited circumstances when a different entity structure would be better. However, as a general matter, the LLC is flexible enough to be adapted to accommodate most small business needs and often the requirements of very large companies as well. Here are some of the advantages of using an LLC:
- Lower Maintenance
It is less work to maintain a limited liability company. Unless the Operating Agreement of the LLC requires annual meetings, it is not necessary for the owners (called Members or Interest Holders) to meet annually to elect directors or officers, as is required by Indiana law for a corporation. This is not to suggest that there are no company maintenance requirements for an LLC, and we would encourage you to read the articles we have written on Piercing the Corporate Veil and Asset Protection.
- Company Governance
An LLC can be structured to resemble a sole-proprietorship, a corporation, a general partnership or even a limited partnership. For example, an LLC can be owned by one person, who makes all the management decisions. A one-owner LLC is often called a single-member LLC, and a “disregarded single-member LLC” is a one-owner LLC that is not required to file a separate income tax return. Instead, the single owner reports the LLC’s income and expenses on the owner’s personal income tax return.
Or, the LLC can have two or more owners with essentially equal authority to act on behalf of the company. This structure is often referred to as a “member-managed” LLC.
A variation on the multiple-member LLC is to create a “joint venture,” in which one or more of the owners are a separate company. So, for example, two or more LLC’s or corporations could join together to form a new business that is operated as an LLC.
Another structure requires the company to observe more formalities and to act more like a corporation, with members electing a “board of managers,” which acts like a board of directors in a corporation. The board of managers then selects officers, multiple managers or a “general manager.” The rights, authority and powers of the board, managers and officers should be carefully described in the Operating Agreement and employment agreements. There are an endless number of variations on this corporate structure. Note that IRS rules place other requirements on an LLC that wants to be treated as an S-corporation.
Finally, an LLC can be structured as a limited partnership, in which one or more owners are “silent partners” with no say in corporate management and no voting rights. The silent partners are often called “Interest Holders,” as opposed to “Members,” the former of which have no right to vote on most company matters.
- Income Tax Treatment
An LLC is ordinarily taxed as a partnership. However, if properly structured, an LLC might be taxed as a sole proprietorship, as explained above in regard to the disregarded single-member LLC. Or, if properly structured, an LLC might be taxed as a small corporation under the “S-election” tax rules.
- Charging Order Protection
An LLC provides a unique form of asset protection that is not available to owners of a corporation. “Charging order protection” refers to an order issued by a court that enables a member’s creditors to seize the income that would be distributed from the LLC to the member, but the creditor could not acquire the member’s ownership interests in the LLC. A charging order is, in a sense, like a garnishment order.
So, for example, if Bill owns 25% of an LLC and is sued by his credit card company for a debt unrelated to the company, then Bill’s creditor (the credit card company) could get a judgment against Bill and a charging order against Bill’s interests in the LLC. When the LLC distributes profits to all the members of the LLC, Bill’s 25% of the distributions would go to Bill’s credit card company, until it has been paid in full. The credit card company could not become a 25% owner in the company and, in essence, replace Bill as a member. If Bill owned 25% of a corporation, as opposed to an LLC, Bill would not be as lucky, and his 25% shares of stock in the corporation could be taken from him, unless the corporation had a buy-sell agreement in place.
It is the opinion of the attorneys at GRIFFITH LAW GROUP that Indiana courts will only give charging order protection to owners of a multi-member LLC. Although there is currently no Indiana case law on point, we doubt the charging order protection would be available to the owner of a single-member LLC. Please read our other articles on charging orders and the single-member LLC.
- Buy-Sell Agreements
If there are two or more owners of an LLC, we recommend that the owners put in place a buy-sell agreement. This would not apply if there are only two married persons owning the LLC, but married couples should include a few special provisions in their operating agreement as a component of their estate planning. Most operating agreements for LLCs contain simple restrictions on how a member can sell or transfer her interests in the LLC. It seems very natural to include basic buy-sell provisions in an operating agreement, given the fact that LLCs share many traits of partnerships. We think that it is then logical and reasonable to expand on those basic buy-sell provisions, by adding a complete buy-sell agreement to the operating agreement. Our law firm routinely includes other provisions that help make company governance simpler, more productive and more orderly.
An LLC is a fantastic entity choice for many businesses, but making the right decisions in how to structure and organize the company requires knowledge, experience and expertise. The flexibility offered by the LLC is a doubled-edged sworn, in that the LLC’s flexibility offers many helpful options but those options can be traps for the untrained and the unskilled. The attorneys in our law firm see far too many LLCs that have been improperly formed by accountants, online form companies and non-legal professionals. Only a knowledgeable and experienced Indiana business lawyer can assure you that your LLC is properly organized and structured to meet your business needs.