10/ 01/ 2002
by Andrew Sherman
This series of workshops will give you an overview and comparison of the basic business formats to consider (proprietorship, partnership, corporation or limited-liability company), both at the outset of a new venture and periodically throughout your company's growth.
Limited Liability Company
The limited liability company (LLC), which has grown in popularity in recent years, is touted by many as the business structure of the future and lends itself to a wide variety of capital-formation options. The concept, developed in Germany and popular in Europe and Latin America for many decades, was introduced in the U.S. in 1977 by the state of Wyoming. The LLC received its strongest endorsement in 1988 when the IRS stated that, for federal tax purposes, an LLC would be treated as a partnership, not a corporation, provided that it met certain requirements. This encouraged virtually all states to pass legislation recognizing LLCs. The flexibility, security and tax savings of an LLC can be significant, and the structure lends itself to the management and structural flexibility needed for just about all capital-formation strategies.
You should structure your LLC so that it qualifies as a partnership under federal tax laws, which means it must lack at least two of the corporate characteristics--continuity of life, limited liability, free transferability of interest and centralized management. Some states have adopted "bulletproof" statutes, which provide that an LLC formed in that state will automatically lack at least two of the four characteristics and will always qualify as a partnership. The majority of states, however, have "flexible" statutes, which allow LLCs to include some or all of the corporate characteristics, with the attendant risk that if the LLC has too many corporate characteristics, it will be taxed as a corporation.
Flexibility for Owners
If you establish an LLC, you'll have tremendous flexibility in structuring economic and management arrangements. The owners of the LLC, who are referred to as members, may elect to manage the LLC themselves or may designate one or more managers (who may or may not be members) to manage the business and operations of the LLC. Capital contributions to the LLC may be in the form of cash, property or services, and the profits and losses may be allocated among the members in any manner they choose as long as it complies with tax laws. As with a corporation, you may create multiple classes of membership, including a "preferred" level that mimics the types of equity that venture investors prefer to purchase.
Forming the LLC
Most states allow any legal entity to be a member of an LLC. However, most statutes require that an LLC be formed by two or more people or entities who sign and verify the articles of organization filed with the secretary of state. To issue a certificate of organization, most states require that you file the following:
- The name of the LLC;
- duration (not to exceed 30 years);
- purpose of the organization;
- address of the principal place of business and registered agent (who has been designated to receive official documents);
- amount of cash invested and description and value of any other property contributed to the LLC;
- any additional contributions that may be required in the future;
- a reservation of the right to admit additional members and a statement of the terms to do so;
- a reservation of the right to continue the business and the vote necessary to achieve continuation; and
- whether there will be a centralized management team.
The most important documents in the formation of an LLC are your operating agreement, which is essentially a substitute for the corporate bylaws, and the member control agreement, which is essentially a substitute for the shareholder agreement or the partnership agreement.
Andrew Sherman is internationally recognized as an authority on the legal and strategic aspects of entrepreneurship and business growth. As a senior partner with McDermott, Will & Emery, he manages a multi-million dollar corporate and transactional practice, representing Fortune 1000 corporations as well as hundreds of technology-driven, netcentric and rapidly growing businesses.
