Limited Liability Companies
Limited Liability Companies, or LLCs, are one of the fastest growing types of new business organizations, and one that Hand Ponist knows well.
Limited liability companies can be organized in any state, and each LLC is governed by the statute of the state in which it is organized. In Indiana, LLCs are governed by the Indiana Business Flexibility Act. All LLC statutes have some fundamental aspects in common – such as limitation of liability for the owners, called members – they vary significantly in important details. The remarks about LLCs made on this page may or may not apply to LLCs organized in a state other than Indiana.
A limited liability company is often viewed as a hybrid of a corporation and a partnership. As with a partnership, forming and operating a limited liability company is relatively simple, with few required formalities. As with a corporation, the owners of an LLC are generally protected from personal liability for the business's debts and obligations.
An LLC is often a good choice for a small, startup business because it offers flexibility on a lot of fronts. If the LLC has a single member, it can be treated as a "disregarded entity" for income tax purposes, which means no tax return has to be filed. The income and losses are reported directly on the owner's tax return, exactly as if the business were a sole proprietorship. Alternatively, the LLC can elect to be taxed as either a Subchapter C or a Subchapter S corporation. If the LLC has more than one member, it can be taxed as a partnership or it can elect to be taxed as a corporation, either under Subchapter C or Subchapter S.
Similarly, an LLC offers a wide range of management structures. It can be managed directly by the members, much the same way as a sole proprietorship or many general partnerships are managed. Alternatively, it can be managed by one or more managers. That's a good choice if the members do not want to be actively involved in the day to day business operations, but that's not the only reason. For example, a sole business owner may choose to set up a manager-managed LLC and name herself as manager. That gives her the alternative to later assign the management responsibilities to someone else or to name an alternative manager to take over the operations when she is unavailable or incapacitated.
Members of LLCs also have a great deal of control over changes in membership, much more than is generally true with corporations. If a shareholder of a corporation transfers his or her stock to another person, the other person generally acquires all the rights of a shareholder, both the economic rights (the right to receive dividends) and the non-economic rights (such as the right to vote for directors). In contrast, if a member of an LLC transfers his or her rights as a member to another person, the only part of those rights that the person acquires is the “interest,” or the economic rights – essentially the right to receive distributions from the company. The person acquiring the interest generally does not become a member – and thus does not acquire the non-economic rights of membership, such as the right to participate in management – unless the other members unanimously consent or unless the operating agreement contains a different provision that permits new members to be admitted without unanimous consent.
Another way that LLCs differ from corporations (and, in our view, a way that LLCs are superior to corporations) is called “charging order protection.” Creditors of the shareholders of corporations can often execute a judgment against the shareholder’s stock, forcing a sale of the stock with the proceeds being used to satisfy the judgment. As a practical matter, that often means that the creditor becomes a new shareholder in the corporation. However, the creditors of a member of a limited liability company is generally limited to obtaining a “charging order,” which is an order from a court instructing the LLC to pay to the creditor any distributions that would otherwise go to the member. It’s very similar to the garnishment of wages. Although the law is still evolving, with some uncertainties remaining, particularly with respect to LLCs with only one member, the exclusivity of a charging order is an important advantage that a member of an LLC has that a shareholder of a corporation does not.
For these reasons and more, we often advise our clients that a limited liability company is the best way to organize their businesses.
If you're starting up a new business -- or even if you have an existing business and want to review its organization -- please consider making an appointment with us to discuss it.