Basic Business Structures — Part 4: The Limited Liability Company

The final part of the Basic Business Structures series will cover the Limited Liability Company.

 

The limited liability company (LLC) is a relatively new form of business organization (for example, LLCs were authorized in Massachusetts as recently as 1996) that are traditionally known for combining the management and tax aspects of partnerships with the limited liability shield of corporations. However, as time has gone on, LLCs have become extremely flexible to structure (and accordingly more complicated to structure). With a well-drafted operating agreement, LLCs can be made to look like almost anything their founders want — this article will discuss the default or popular features of LLCs.

LLCs are required to file a certificate of organization with the state Secretary of State’s office, and annual reports thereafter. Although LLCs are generally not required to have a written operating agreement (with the state LLC Act and the course of dealing serving as a de facto operating agreement), some jurisdictions do require all LLCs to have them. Owners of an LLC are known as members; like general partners, members normally have both management and economic interests in the LLC. LLCs that are managed by all their members are known as member-managed LLCs; alternatively, members may choose to select a number of the members, or even non-members, to manage the LLC — this is known as a manager-managed LLC. Normally, LLCs follow the pick-your-partner rule — that is, the management interests of partners, or members in this case, cannot be transferred without the consent of the other partners/members (although the right to receive profits or tax credits so distributed may be freely transferred) — however, a recent trend for some LLCs’s operating agreements has been to allow members to transfer the whole membership interest without the consent of the other members; this can be useful for attracting investors who are looking for an investment they can more readily realize a return on.

Unlike general partners, members generally do not have agency power to bind the LLC — this can be changed by the operating agreement. As stated before, LLCs can be member-managed or manager-managed. In a member-managed LLC, management decisions are made by consensus or vote of a majority of the members, as defined by the operating agreement. In a manager-managed LLC, managers (who can be members or non-members) are selected to make management decisions (by consensus or majority vote if there are multiple managers); members then are generally limited to selecting managers and ratifying major transactions such as significant sales of assets or M&A transactions. Thus, manager-managed LLCs are reminiscent of the management structure of many corporations. Like corporations, LLCs, as the name suggests, have a limited liability shield.

LLCs, interestingly, have three different federal tax classifications — LLCs can choose to be taxed like a partnership, or as a Subchapter C corporation, or, if there is only one member of the LLC (a single-member LLC), can choose in lieu of partnership taxation (which requires two owners) to be disregarded for taxation purposes (so the LLCs’s profits, losses, and credits are treated as those of the member). By default, LLCs are either disregarded (if they are a single-member LLC) or classified as a partnership, so if the LLC chooses to be taxed as a C corporation it must notify the IRS that it wishes to be taxed so. Most state revenue agencies follow the federal tax classification; however, a few states subject LLCs to the corporate or franchise tax no matter what their federal classification.

 

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