Setting Up An LLC
Are there any special rules for naming a Limited Liability Company?
In all 50 states, and each state obviously has its own little nuances, in order to name a company, whether it's a limited liability company, or a corporation, or any legal entity, you have to have a name that is not similar to someone else's name out there. So, for instance, there are a lot of really big companies out there, like Microsoft. I mean, I couldn't go out and just start Microsoft Corporation, because it already exists. So a lot of times what you can do, without the expense of going and forming a corporation and then finding out that the name's already taken, you can actually do a name check. There are – you can try to do it yourself, sometimes you can be bogged down. You can go online to companies like Legal Zoom; you can go to an attorney and you can actually have them check your name for you for a nominal fee.
What are an LLC's "articles of organization"?
The articles of organization for a Limited Liability Company (LLC) are the formation documents. In the corporate parlance the articles of organisation are called the charter. It's the thing that forms the Limited Liability Company (LLC). Every state varies, but typically in the articles of organization, the state's going to want you to list out the name of the Limited Liability Company (LLC), they'll want an address, they'll also want what's called a registered agent or an agent for service of process. That is an individual living within that state or resides within the state where you formed the LLC who is eligible to receive any important governmental or legal correspondence on behalf of the LLC. In addition there are other things that you can put in the articles of organisation, and again it varies state by state. Sometimes they want you to list out in the articles of organisation who the managers are or people that are authorized to sign. Most of the time with just those basics in the articles of organisation you can go ahead and form the LLC, file the articles of organisation along with a filing fee in the jurisdiction where you want to start the LLC, and once that happens and it's accepted you have a valid Limited Liability Company (LLC) and a separate legal entity under your name.
What should I include in LLC's articles of organization?
Every state's laws are going to tell you what you have to include in LLC's articles of organization. So, there's two parts to this. There's what I "must" include, and what you "might" want to include.The "must" want to includes will vary, like I said, by every state's limited liability company laws. But typically they are the name of the company. A lot of times there's a statement of purpose. With many states you can just say, "Anything lawful that a limited liability company can do." Others might actually want you to say what it is that you do. "Real estate investing," or something like that. Typically an address. There is going to be a registered agent or person who can accept the legal documents. You are going to have to sign it and show that you're an authorized person who can actually sign that as well.
What mistakes should I avoid when drafting articles of organization?
I think probably the biggest mistake is not doing a little bit of research. I think first off, the biggest mistake is probably choosing a name that's already been taken. And, even though we've talked about that before in another segment, I think going out and doing a name check is always one of the first things you want to do. And I think, obviously, not even just doing a name check with the state, but maybe just taking a look at it on the internet, just see if anyone else is using it, because who knows? One day you might want to get a trademark, or you might have someone breathing down your neck suing you because you're using a very similar name, even if it's in another state. Now, that being said, other mistakes mostly have to do with trying to put additional articles inside the articles of organization other than the ones that the state typically requires. And, when I say that, many lawyers and companies that do legal document preparation, like Legal Zoom for instance, they can put other articles inside, but they're ones that have been kind of tried and true, and ones that have been accepted before. When individuals go and start trying to say how profits are going to be distributed, or start saying things in articles of organization that should be left in an operating agreement, many times they can be refused by the state because they don't want to read through all of that stuff, and they just want cleaner ones. So, I think taking a look at what the state's form is and following the form as closely as possible is always your best bet. Otherwise, using a lawyer or using a document company are always great options if you want to save time.
What is an LLC "operating agreement"?
The LLC operating agreement is the document; it's the contract between all of the members of the Limited Liability Company that is very similar to a General Partnership's partnership agreement. So, the Limited Liability Company will set out what the name of the company is, what it's address is, the general type of business that it does. It'll set out the names and the contributions of all the members, and who is allowed to manage it. Many operating agreements also want you to set out who it is who is called the "tax matters member"; someone who's responsible for handling the CFO, or what's loosely described as the CFO duties. Additionally, the LLC operating agreement sets out the contributions, allocations of profits and losses, how other members are added, how members are ousted or what happens if a member dies or decides to voluntarily leave. There are just so many things that you can do and, to tell you the truth, that is probably one of the best aspects of owning a Limited Liability Company is that the operating agreement can really be narrowly tailored to what it is that is very key for you as an individual business person, and for the other people with whom you're in business. In this way, it's a little bit unlike a corporation, where bylaws and corporate law kind of dictate, for instance, how many days you have to give notice of meetings. None of that stuff's really done in Limited Liability Company law, and you can set that forth in your operating agreement to your taste. Now, drafting one of those is not an easy task, and I don't necessarily recommend it for the layperson. I do believe that going and talking to an attorney is the way to go when you're drafting up an LLC operating agreement and I think before you go you'd want to take a look at all the different sections that we discussed, and you'd want to have some answers for him or her; that would really help out with the drafting part.
What are "goodwill payments"?
Goodwill, or the goodwill of any kind of a business, is that thing that's intangible. There are a few things that are obviously intangible, and it's one thing. You can take a look at computers, and office equipment and buildings, and you know how much they're worth. You can also even take a look at other intangibles, like a patent or a trademark, and say "Oh, that's about how much that's worth." However, the goodwill is something that is engendered in a brand. For instance, like a Coke or Pepsi; something that's got amazing amounts of goodwill, so that when someone includes that in a television show, or if someone else is a partner and their partner is Coke or Pepsi, then they all of a sudden have some more legitimacy to them. So, there's goodwill that is engendered there. A lot of times when individuals want to sell a piece of a business, whether it's a limited liability company or other, even though a business, goodwill is a portion of what the value of a business is worth in determining how much they should be paid. The place where you see that the most is a lot of times in mergers and acquisitions, when two companies are merging together; you'll take a look, and when they're trading stock for each other in very crazy, big deals, goodwill is a very big portion of how much a company gets paid for their stock.
Why should an LLC include "capital contributions" in its operating agreement?
Capital' is essentially money. It's essentially payment. Payment for the membership in a limited liability company. Capital contribution can be done in the form of cold, hard cash. It can be done in the form of goods or services that have been previously provided. For instance, if you had a limited liability company with five members, and one of the members put in a certain abount of cash - ten or twenty or a hundred thousand dollars - and three other members put in a smaller amount of cash - maybe the same exact amount divided over three and then a final person put in twenty or thirty thousand dollars of professional services. That total would then be the total amount of capital that was raised when the business was formed, and can be used as a basis for distribution of profits or allocation of losses. It just depends completely on the operating agreement and kind of how you want that structured.
Do I need to outline ownership percentages in my operating agreement?
Definitely, you must outline ownership percentage. That is probably one of the biggest bones of contention that you're going to find is whenever profits start coming in. People are going to be allocated those profits, they're going to start receiving some of those profits and that's the reason why everyone gets into business. They'd like to be allocated more profits than losses. And if you state what the ownership percentages are, and that provided that the operating agreement shows that allocations and distribution are going to be made pursuant to those set percentages, then you know exactly how much you going to get paid whenever the income statements come out and you see how much money you've made in the last month or quarter. Now, they become a little less necessary if there's a different method of allocating profits and losses in the operating agreement. For instance, some people who are passive investors might get a smaller amount of allocated profits and losses than people who are active participants in managing the business. However, a lot of times that can be done through the payment of salaries. For instance if there are five people in a limited liability company, and two of them day-to-day run it, let assume that it's a restaurant. Two of them day-to-day run it they can be paid a salary. That salary will come out of the profits and then what's left over could be split five ways amongst everyone. But the two individuals who are getting a salary, they would be able to actually receive more money even though it really isn't more profit. Now, that does have tax consequences, depending on how you play it out. Whether or not income is distributed to you as a dividend essentially or as profit or whether it is distributed to you as salary. So that's something that you want to get with a tax person to defiantly hammer down before you make that decision.
Do I need to outline voting procedures in my operating agreement?
Voting procedures, probably next to how much money I'm going to have to put in to get out are probably the next, most contentious part of an operating agreement and whether or not someone gets a vote- how their vote counts- when voting is done- what gets voted on are all very important concepts and ideas whenever you're starting a limited liability company. So if you wanted to lease new office space, there would probably be some vote that was taken and if you stated in your operating agreement that important decisions or important contracts, or even if it's contracts over $100,000, you need a unanimous decision, then one person, one of the members of the limited liability company, could stop that from happening. So when you are forming and crafting an operating agreement you need to, before you go meet with the attorney or the professional that's going to be drafting it, you need to sit down with the other members and say how do we want to do things, how do we want to, not run the company itself, but how do we want to run, you know, kind of how the company is run, which is a bigger picture item, and that's what voting does.
Do I need to outline my LLC tax status in my operating agreement?
Most of the time that is done. Obviously, just because your operating agreement says what want your tax status to be, doesn't mean it will be that. You can put in an operating agreement that our tax status will always be a flow through entity. But if someone goes and files paperwork and says they want to be taxed as a corporation, you are going to get taxed as a corporation. What happens in an operating agreement is you can provide for that so that if someone does that, there the person that has to come up and pay the penalty or whatever lost profits or increased taxes happen. So typically what people do is say here is how we want to be taxed, and each member agrees, not to take any actions that would be inconsistent with that type of tax treatment.
What mistakes should I avoid when drafting a LLC operating agreement?
I think the most common mistake is not thinking everything through before they go see an attorney or, honestly, drafting it yourself. Those are probably the two biggest ones. If you try and draft an operating agreement yourself, I'm not going to say you can't do it because there are forms out there and there are books that you can get and you might be able to do something decent. However, I am a firm believer that if you do that, you do run a little bit of a risk. You might save some money on legal fees but there might be some sort of problem or occurence that happens down the line that maybe that book or maybe your limited knowledge of how that book works wouldn't allow you to actually count for. So you need to kind of weigh that out on the front. If indeed you go see an attorney though, which can be pricey, I mean they're, attorneys can charge quite a lot and they do charge by the hour, you need to be very specific on what you want drafted up and how you wanted it drafted up because back and forth and back and forth, reading an agreement and changing it and reading it and changing it, that will really run up your tab, so if you come in with a set plan and you know exactly what you want, that can make the experience a little less painful. Not painless, but a little less painful.
