You’ve Decided You Need to Form a Liability-Limiting Business Entity – Is an LLC the Right Choice? (Part 1 of 2)

Another in a series of posts about legal issues that arise for early-stage businesses. Previously:

If you’ve decided you need to form a liability-limiting business entity, your next question will likely be  “which entity is the best for my company today?” There are a number of factors to consider, but first, you should understand the key attributes of your various options. First, limited liability companies.

High-Level Summary

Limited Liability Companies (LLCs) are often the preferred choice for new businesses. They are the easiest to set up, they have the least formalities to follow and as a default setting are treated by the IRS as “disregarded” – meaning that they are not taxed separately from their owners. If the Company earns profits, its owners will be deemed to have received the profits. If the Company suffers losses, the same is true.

As is the case for other business entities, many view forming an LLC as a Delaware LLC as a best practice. Delaware business law is seen as one of the friendliest-to-business jurisdictions in the country and has the most-developed business case law in the country (which for a business owner means the legal guidance available is more clear than it may be in other states). Many states model their limited liability company law after Delaware.

Who owns an LLC?

In LLCs, members own membership interests. The corporation parallel to a “member” is a stockholder/shareholder. Membership interests are akin to shares of stock in a corporation. 

Some LLCs will draft their Operating Agreements (a term synonymous with Limited Liability Company Agreements) to have “units” which operate just as shares of stock would. This is often helpful from a conceptual standpoint as people are generally much more familiar with the corporate structure than the LLC membership interest structure (which is expressed as a percentage).

It’s possible to create membership units that parallel the structure of common and preferred stock – with owners of different types of units (for instance, Class A Units and Class B Units) receiving different rights.

Who Manages an LLC?

Either members or managers manage an LLC. In a member-managed LLC, the members (or owners) of the LLC directly manage the LLC. In a corporation, this would be the same as the shareholders managing the corporation (though corporations generally require a board of directors). The members may or may not hire executives who would report directly to the members.

In a manager-managed LLC, the members of the LLC elect certain individuals (who may or may not also be members) to manage the LLC. Typically an LLC’s Operating Agreement will denote certain activities and thresholds that can be taken by a vote of the managers, or, if such thresholds are exceeded, require a vote of the members. Executives hired would report to the managers and in turn, the managers report to the members who elected them.

This information is intended for informational purposes only. Prior to making any decisions regarding the creation of a business entity, you should seek the advice of an attorney and tax professional.

If you like to discuss this article with an AEGIS Law attorney, please contact Alex Prasad (aprasad@aegislaw.com).