The 5 Biggest
Mistakes Made by New LLCs
Mistake #1
Doing business Before the LLC is Formed
You are personally liable for
any business activities or transactions that take place before your
LLC is formed. A person can sue you years later for something you
did today. If your business becomes successful, those early
acts could cause you to be subject to a personal lawsuit.
Don't think it has not been done. With over 70,000 lawsuits
filed a day, this world is filled with people and their predatory
litigation attorneys looking for successful small businesses to
attack.
Many new business owners put off
the formation of their LLC while they work on the other details of
starting a business. Once you have decided to start a business, it
is a much smarter move to form your LLC at once and then have the
LLC engage in the other start up activities as opposed to you
personally. This is the best way to ensure your liability
protection.
In summary, once you have
decided to start a business, form your LLC right away. This will
ensure you have more liability protection and if will save you the
money and stress of having to form one on an expedited basis to
avoid losing business or delaying other start up activities.
Mistake #2
Failing to Actually Issue Ownership Interests in the LLC
Many business owners create an
LLC but never actually issue ownership interests (known as
Membership Units) to the persons that are going to be owners of the
LLC (known as Members). It can be easy for you mistakenly think
that because you created the LLC, your are automatically the owner
of the LLC.
The fundamental premise of an
LLC is that it is its own separate entity. When an LLC is formed by a
state agency, it does not have owners. Membership Units in the LLC
must be issued to the persons who will be the owners. This issuance
transaction needs to be in writing. The LLC Operating Agreement is
the typical place where the LLC issues shares to Members and usually
the Members agree to contribute a certain amount of money to the LLC
for those Membership Units (this money obligation is known as a
Capital Contribution).
Make sure that after your LLC is
formed, you complete this next step. It is vital to your LLC
business because an LLC once formed is a shell entity without any
ownership attributes until Membership Units are issued to Members.
Mistake #3
Failing to Create a Management Structure and Appoint Officers
An LLC needs to have a
management structure. A management structure determines who has the
authority to make decisions on behalf of the LLC. There are two
management structures. A member-managed LLC is when the members
automatically have the rights to operate and manage the LLC
business. The second is a manager-managed LLC which creates a
corporate type structure. A Board of Managers is created and
persons who are appointed to that Board have the authority to run
the business. All LLCs should appoint the officers (President,
Secretary, Treasurer) of the LLC.
The best place to create a
management structure and appoint initial officers is in the LLC’s
Operating Agreement. All LLC’s should have an Operating Agreement
as this agreement creates the set of rules for your LLC. If you are
a single member LLC, this becomes even more important because you
run a higher risk of losing liability protection if you ignore your
entity as a separate entity by not having a separate set of official
rules for your LLC.
Remember, your LLC is a separate
and distinct entity and this is important to preserve the layer of
limited liability protection afforded by LLCs. If you do not comply
with the standard protocols for LLCs, a predatory attorney can try
to sue you personally and say that you should be personally liable
for the LLC activities because you did not treat the LLC as an
entity separate and apart from yourself.
Now, the Georgia Limited
Liability Act does have default management provisions that apply if
your LLC does not have an Operating Agreement, but those laws are
always changing and they can be difficult to apply. Plus, if you
have other Members, then disputes can arise as to what voting
requirements, profit allocations and other rules apply. The
Georgia laws may include provisions that you do not want for your
LLC. Another great benefit of LLCs is that the Members can decide
amongst themselves how they operate their LLC. Use a well drafted
Operating Agreement for your LLC and get all of your Members to sign
the Operating Agreement.
Mistake #4
Failure to Get Investment Obligations in Writing
The Georgia Limited Liability
Company Act requires that all agreements by a Member of an LLC to
contribute money to the LLC must be in writing. An oral agreement
is not enforceable under the law.
If you are planning on starting
a new business with other persons, you will likely get together and
decide on how much of the business each of you will own and on what
obligations each of you are agreeing to with respect to that
business. Obligations usually include how much money you are each
going to contribute to the business and what kind of services and
time commitment each of you will devote to the business.
At the beginning of a business,
these conversations take place and everyone agrees. An important
discussion is how much will the business require in money before it
can generate its own cash to operate the business. This amount is
known as start-up capital.
A typical conversation goes like
this:
Anne: “John, we are going to need $20,000 over the next
year to start this business. If we are going to each work equally
and you agree to put in $ 5,000 of the capital, I agree to issue to
you 25% of the ownership of the business.”
John: “Anne, that sounds fair. We will each work
equally in the business but because you will be contributing $15,000
and I will contribute only $5,000, the 75%-25% allocation makes
sense. Now, I am looking at our budget and most of the money will
not be required until 5 months from now when we will move into
office space and need to pay our vendors for products purchased- I
will contribute my $5,000 then- is that okay?”
Anne: “Sure, as long as we are in agreement as to
amount, I can front the initial expenses until the 5th
month and then the LLC will need your $5,000.”
Then John and Anne form their
LLC and starts their business. . . forgetting to ever document the
agreement among LLC owners (known as Members) in any written
agreement. Five months later, Anne asks John to contribute $5,000
and he says he does not feel like he should contribute this money
because he has worked more on the business than Anne or. . . perhaps
he decided to invest the money elsewhere at that point.
This is a common situation that
multi-member LLCs find themselves in often. In this situation
the LLC and Anne lose out. Meanwhile John has received all of this
ownership interests in the LLC and does not have to contribute the
rest of the money he orally promised. Any monetary or
services obligations should be set forth in writing.
Mistake #5
Thinking that an LLC is a Foolproof Layer of Liability Protection
Yes, it is established that a
Member of a properly formed and maintained LLC is not liable for the
debts, obligations and lawsuits of the LLC merely by being a Member
of the LLC. But, in a realistic business context, persons who are
Members are usually not passive owners of the LLC. They are
also active managers and operators of the LLC business.
In today's litigious world, all
businesses should be run through a limited liability entity such as
an LLC. The LLC liability protection is a significant
protection vehicle. However, the LLC layer of protection does
not extend to all potential liabilities that can arise in the midst
of running an LLC.
For example, you may be in a
company car driving to see a client when you are in an accident.
You will be personally liable for that accident regardless of the
fact that, at the time, you were working on behalf of your LLC
business. The LLC laws do not cover personal negligence. You LLC
should always have insurance to cover these types of business
related accidents. Do not ever think that the LLC is enough to
protect you in these circumstances.
Similarly, there are some laws
that hold you liable regardless of whether you are operating through
an LLC. The most obvious one that might apply is if you are a
licensed professional. Doctors, lawyers, accountants, real estate
brokers and dentists, for example, are always personally liable for
acts of malpractice. If you are a licensed professional, make sure
you get the proper insurance.
Also, there are certain tax,
environmental and securities laws that you can be held personally
liable for if your LLC is in violation of those laws and you were
the responsible manager. Do your homework in performing the
administrative and other tasks of your LLC and retain the proper
professionals to advise you when appropriate.
Finally, you cannot use your LLC
to engage in fraud or hide behind the LLC to protect yourself when
you engage in fraudulent or unlawful acts. If you break the law or
try to defraud others, the law will hold you personally accountable.
* * *
In summary, the LLC is a
wonderful vehicle for providing Members with limited liability
protection. But, in order to preserve that protection, you cannot
just form an LLC and then forget it exists. Make sure you do the
necessary things to honor your LLC as a separate entity and also
know that the LLC should not be your sole means of protection- get
insurance when it makes sense and always invest in the required
knowledge for operating your business which includes getting the
right help when needed in your business!
