How a LLC Works: Everything You Need to Know
Wondering how a LLC works? It all begins with the filing of the articles of organization with your state's filing office.3 min read
Wondering how a LLC works? It all begins with the filing of the articles of organization with your state's filing office. This is often the Commissioner of Corporations or the Secretary of State.
Overview of a Limited Liability Company
A new legal business formation, the limited liability company (LLC), was recently introduced. All states recognize this business type. An LLC has some of the same benefits of other entities, such as the pass-through tax status of partnerships and the limited personal liability for owners of corporations. Several states (Tennessee, New Jersey, Massachusetts, District of Columbia, and California) require an LLC to have two owners. The exception is if a spouse is a co-owner.
Forming an LLC is one of the more popular options for new business owners looking for ways to limit their personal liability for business debts or claims against the business. While an LLC is a good choice for many, it is not necessarily the right choice for all business owners. For some, forming a corporation is a better choice. If, for example, your business would benefit by having financial interests formally separated from management, forming a corporation would be more beneficial than forming an LLC.
Formation of an LLC
In an LLC, owners are referred to as members. Ownership can be by one member or many members. Members may be individuals, other businesses, or both.
When the LLC is formed, it is the responsibility of the members to set up the management operating structure of the LLC. This involves establishing the requirements to become a member. Members will also determine the procedure for withdrawing or transferring a member's ownership interest in the LLC.
To officially and legally form an LLC, the appropriate paperwork must be filed with the state agency. For example, an LLC formed in Texas must file a certificate of formation with the Texas Secretary of State. In Arizona, an LLC is formed once the articles of organization have been filed with the Corporation Commission.
In these documents, the members identify the basic structure for operating the LLC. It will also be determined if the LLC will be member-managed (managed by all members) or manager-managed (managed by one or more members). In a member-managed LLC, participation in day-to-day operations is authorized for all owners. In a member-managed LLC, only the named managers are authorized to participate.
Important issues that owners must decide on relating to membership in the LLC include:
- The type of capital contribution.
- The amount of an owner's contribution.
- Allocation of profits and losses of the LLC among the owners.
- The voting rights when important decisions must be made.
- Setting up specific restrictions when a member wants to transfer their interest in the LLC.
The decisions made by the owners on issues is generally referred to as an LLC operating agreement. Although not required in most states, it is advisable to put the decisions in writing.
Dissolving an LLC
The owners control the dissolution of the LLC. They determine when and under what conditions a dissolution takes place. The dissolution date can be decided at the initial forming of the LLC. This can be on a specific date or after a specific event involving a member, such as bankruptcy or death.
If a condition of dissolution is not in place, the existence of the LLC will remain in a perpetual condition by the state. In this situation, a majority vote by the owners will dissolve the LLC. The exception would be if a greater percentage of votes by the owners is required according to the operating agreement.
Benefits of an LLC
- LLC owners are not held personally liable for the debts of the business. This includes things such as legal settlements, judgments, and lawsuits.
- The only risk LLC owners incur is the loss of their initial contribution to start the business. The exception is that if you personally co-sign a loan, you are personally liable regardless of the business structure.
- Only the assets of an LLC can be used to repay debt.
- For co-owners of an LLC, in the event your partner incurs personal debt, creditors cannot come after the business.
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