What Is a Limited Liability Company?

Limited liability company (LLC) members enjoy certain liability protections similar to partnerships. An LLC is a type of business formed by filing state documents such as Articles of Organization. There is no involvement from federal entities, including the IRS, in an LLC's founding. An LLC is a hybrid organization with characteristics of both partnerships and corporations.

An LLC is owned by its members so, as such, it requires at least one member to operate. Unlike a corporation, an LLC is not a separate tax entity, but rather a “pass-through entity.” Because of this status, LLCs are not required to pay federal income taxes, although certain states do impose annual taxes.

Who Are LLC Members?

LLC owners are called members. After establishing the LLC, the organization's Operating Agreement will detail who its members are. These members have vested interests in the rights of the business, including the rights to share company profits and losses, to manage the company, and to receive company distributions. However, members do not have owner shares like in a corporation; instead, each member is an owner of the LLC.

Limited liability companies may also have different member classes with different rights. For instance, one member class may have more rights to company management than another class. Another class may have more decision-making rights, while other classes are limited in making those decisions.

Two Types of LLC Memberships

There are two distinct types of limited liability company memberships:

  • Single-member LLC.
  • Multiple-member LLC.

While the number of members varies between the two, single-member and multiple-member LLCs operate the same way. The only difference is in how they are taxed.

Single-member LLCs have only one owner who is referred to as the “managing member.” Multiple-member LLCs have more than one member, but one person is generally in charge in order to simplify operations.

Who Can Be an LLC Member?

There are no restrictions on LLC membership except that each member is at least 18 years old. LLC members don't even have to be United States citizens.

Other entities can be LLC members, including:

  • Corporations.
  • Pension plans.
  • Other LLCs.
  • Holding companies.

Certain states require LLC members to be identified, but not every state has this stipulation. The only exception is that Professional LLC (PLLC) members must identify themselves and have their professional licenses and other credentials examined when the company is being formed. PLLC members must register in the state for their respective professions. Just keep in mind that state laws do vary on what types of professionals may form a Professional LLC.

LLC members' responsibilities and rights are detailed in the Operating Agreement and are defined by state regulations. Check with your state for more information on specific LLC regulations.

Managing Members

Owners with the power to manage the LLC are called “managing members.” These are different from passive members in that they are more directly involved in the LLC's operations. Unlike passive members, managing members are authorized to sign contracts, make purchases, and enter into binding agreements on behalf of the LLC.

Management of an LLC

How an LLC is managed should be detailed in the Operating Agreement. Members who do not create an Operating Agreement are subject to state rules, which aren't necessarily the ones you want for your business, so it's always best to have your own written agreement when establishing your LLC.

Most LLCs can be categorized as either:

  • Member-managed.
  • Manager-managed.

Manager-managed LLCs involve third-party managers who are typically paid executives with ample business experience. Members may choose to manage the business themselves, which defines the LLC as member-managed. LLCs do not have formal boards of directors, but it's a good idea for members to meet at least annually to discuss the business.

Making Major Decisions

How an LLC's members make decisions should be outlined in the Operating Agreement. For example, you may require majority approval before making a decision for the business. This may involve two-thirds of the members agreeing on a decision or even a unanimous vote. It's not uncommon for decisions such as bankruptcy to require a 100-percent member agreement.

Deadlock

Every Operating Agreement should discuss what happens in the event of a deadlock where LLC members do not agree on a decision. One possibility is to resolve the matter with arbitration or mediation. When a resolution cannot be reached, it may be time to end certain member relationships.

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