The L.L.C. - a New Way to Do Business

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The L.L.C. - a New Way to Do Business

Part 1 - What it is and How to Form an L.L.C.

Step 1: Find the Right People: There are many legal, financial and emotional considerations when entering into a business. It is important to be cautious and choose wisely the form of business; its profit, tax, reputation as well as legal formalities must be considered.

The OTHER consideration, the MOST important of all is: will all the members of the business get along in the long term? Watch for signs of problems before they get to legal proportions. Are all proposed members able to make meetings? Do they all understand all of the known issues and challenges ahead? Are they financially able to provide their share of necessary capital? These and other considerations are of utmost importance. They are the difference between minor legal maintenance costs and major litigation expense.

With the enactment of the Beverly-Killea Limited Liability Company Act (Stats 1994, chap 1200), codified at Corporation C зз17000-17705, California joined many other states that provide for the formation of an L.L.C. What this is, how to form one, what it means are the topic of this outline. Part 1 explores the bare bones- what it is and how to make one go. Parts 2 and 3 will explore the questions: why an L.L.C., and tax, and intellectual property considerations.

What is an L.L.C.?
1. A limited liability company is a form of business that combines the benefits of liability insulation of a corporation with the direct taxing feature of a partnership. There are many forms including the corporation, partnership and sole proprietorship, joint venture and association, and others.
2. An L.L.C. has the "corporation"-like feature that insulates its owners from tort and business (contract) liability for errors made in the business. Note that this an insulation, not a brick wall or armor. Someone who sues it may sue the L.L.C. and (of course) may also name the owners, agents and managers.
3. Unlike a Corporation, however, the L.L.C. offers provides the flexibility of a partnership and the basic financial benefit that it is taxed "like a partnership" so that IT does not pay tax on profits, rather, the profits are distributed to and taxed on L.L.C. "Partners." It allows limited liability with pass-through tax treatment. It also does NOT have perpetual existence if is to be structured like a partnership.
  1. It has the freedom to structure management rights and financial interests in almost any configuration the parties wish, like a partnership. Almost, for among other reasons, because the L.L.C. must not have continuity of life like a Corporation or it may alter its tax status.
Forming an L.L.C. The Formalities:
1. First step, after deciding whether to form an L.L.C. (Topic for Part 2), is to prepare a FORM L.L.C.-1, articles of organization and file them with the secretary of State. This is a printed, prescribed form. The formalities, capitalization needs and other requirements are due to the factors that the government is allowing people to do business, benefit from a type of tax treatment and yet also benefit by the insulation factor. The government must be sure that these businesses can respond to damages, act honestly and be available in the state.
  1. Operating Agreement: The members of an L.L.C. must enter into an operating agreement, either before or after the filing of the articles of organization. Corporation C з17050(a).
  2. The operating agreement may be oral. Corporation C з17001(a,b). NOTE: ORAL operating agreements are the MOST EXPENSIVE type. We strongly advise that the agreement be in writing, and it is essential that it address all material issues among the members. The cost and complexity of the agreement will depend on the nature of the L.L.C. and its business. Memories fade, members change attitudes and people begin to differ on what they all "thought" they were getting into.
  3. As with partnership agreements, completing the L.L.C. operating agreement may involve negotiating and drafting. This differs in a cost perspective to a Corporation where there are more "standard" bylaws, and later other agreements such as shareholder and employment or personal services and "loan out" agreements. The L.L.C. thus may get more expensive to set up.
  4. Within 90 days after filing the articles of organization, the L.L.C. must file with the Secretary of State a Statement of Information: The From L.L.C. 12. (Under Calif. Corporation Code з17060.):
    1. The form asks for the name and address of the L.L.C.'s managers (if it is a manager-managed L.L.C.) or its members (if it is a member-managed L.L.C.)
    2. It requires a statement of the general nature of the L.L.C.'s principal business activity,
    3. The name and address of the L.L.C.'s agent for service of process, and
    4. The address of the L.L.C.'s principal business office.
    5. TAX prepayment: An L.L.C. doing business in California is required to pay an annual franchise tax of $800 (see Rev & T C зз17941(a), 23153(d)(1)).
    6. This amount is the same as Corporations pay. It must be paid on or before the 15th day of the fourth month of the L.L.C.'s taxable year. (See: Rev & T C з17941(c).) Corporations do not have this privilege.
    7. CAUTION: If the L.L.C. pays the $800 franchise tax when it files its articles of organization, the Franchise Tax Board may treat the prepayment as an election by the L.L.C. to be taxed as a corporation in California. While this election is not binding on the L.L.C., the L.L.C. will be required to expend time and effort to demonstrate to the Franchise Tax Board that it did not intend to be taxed as a corporation. Accordingly, be advised, if you intend your L.L.C. to be treated as a partnership for California tax purposes, consider not paying the $800 franchise tax when filing the articles of organization.

These steps may sound daunting, however they pale in comparison to the basic decision whether to be and L.L.C., partnership or corporation, joint venture or to form a strategic alliance. This decision is the topic of part 2.

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