Limited
Liability Companies (LLCs):
Avoiding
Disasters, Mistakes and Confusion!
By Darius M. Barazandeh,
Attorney at Law / M.B.A.
I see it several times per day, everyday: An
LLC disaster waiting to happen! No matter where I travel or with whom I
speak, it’s clear that small to mid-sized business owners are not getting
proper instruction on how to create, run, and maintain a ‘rock solid’
LLC. Did you or your attorney form your LLC? Are you now left with a stack
of papers and confusion?
One comment that I repeatedly hear is, “Well, my attorney set it up for me
two years ago…so everything is rock solid.” Usually, without much
probing, I soon learn that little else has been done since then. I will
typically find that even the attorney may have missed a few steps along the
way! In fact, we have uncovered 24 mistakes/traps that LLC owners face all
the time! Many of these mistakes are even made by attorneys, experienced
business owners, and very talented people. So if you want to avoid disasters
and create a ‘rock solid’ LLC…let’s get started!
While I can’t cover all 24 mistakes and traps in this article, let’s
talk about the first 5 mistakes in some detail:
1) The ‘Fatal Death’ Personal Liability Clause
A handful of states have a strange option in their articles of organization
forms which can be d-i-s-a-s-t-r-o-u-s. Some states require the filer to
select whether or not LLC members will be personally liable for the business
debts of the LLC. Obviously, members should not be personally liable for LLC
debts and obligations! This is the reason you are forming an LLC to begin
with…remember? Carefully read the articles of organization or similar
formation documents in all states. Make sure that you and your attorney do
not accept member personal liability for business debts. If you had an
attorney or filing service submit your organizing documents for you, then it
is always a good idea to ‘double check’ this area. Make modifications if
needed. You would be surprised how many times it’s a secretary, legal
assistant or clerk who actually completes your precious articles of
organization. Just because a box exists, this does not mean you should
‘checkmark’ it!
2) Not Maintaining "Required" Records
Here is an area where much confusion exists. When I talk about required
records, I almost always get the same response, “I don’t want to keep
records…that’s why I chose the LLC over a corporation!”
Hold on one minute…because you may be surprised to learn that almost every
state requires the LLC to maintain certain key records. In fact, maintaining
‘key records’ is one of the few ‘formalities’ that states do impose
on the LLC. As a result, this can be a prime target area of attack if a
suing attorney, the IRS, or a bankruptcy court wishes to ‘set aside’ or
‘penetrate’ the LLC.
We have reviewed this area in much detail for all 50 states and D.C., and I
can tell you that each is different. Regardless of what your attorney,
accountant, best friend, or local guru tells you, this is a must do area!
Some common records include: copies of resolutions, unanimous consent forms,
copies of meeting minutes, tax returns (from 3 to 6 years), the names and
addresses of all current and former members and/or managers, a copy of the
operating agreement and more!
3) Failing To Understand and Review Your Operating Agreement
This is an all too common mistake. The operating agreement is perhaps the
most important document of the LLC! The operating agreement is an
‘internal’ set of rules for the company. It is basically a contract
among members of the LLC. Even if you are the only LLC member this document
is very important! We continually find that many business owners have a
generic operating agreement that has never been reviewed or even signed by
members!
Even worse, most operating agreements are usually missing some KEY
components. In fact, we have isolated 43 to 45 key components that must be
included in almost all operating agreements. Most canned and even
‘customized’ agreements only contain about 25 to 30 of these components.
At a bare minimum, you should understand what the ‘best practices’ are
regarding operating agreements and then compare this ‘gold standard’ to
what you have. Special tax treatments for the LLC (such as the popular
S-corporation tax treatment under Sub Chapter S) will require additional
terms and controls!
4) Failing To Complete the "Big 10" After Forming The
LLC:
It does not matter whether you file the LLC paperwork yourself, hire an
attorney or other service these things must be completed. This is one
mistake we see over and over again! Most business owners routinely forget to
complete the ‘Big 10’ important steps within 30 days of forming the LLC.
Here are 7 of the steps:
1) Conduct the First Organizational Meeting of the LLC – This is really
important and will allow you to create solid safeguards and ‘often
forgotten’ controls. There are about 11 things that should occur at this
meeting!
2) Obtain Employer’s Identification Number (‘EIN’) from the IRS
3) Register Your Business Name with the County Name Registrar
4) Register with your State Department of Revenue and Comply with State
Sales Tax Rules
5) Collect Member Capital Contributions and Transfer Cash or Hard Assets
into the LLC (With proper instruction this is simple…if done incorrectly a
liability disaster can occur!)
6) Obtain the Proper Business Licenses
7) Review Insurance Coverage Needs and Limitations
5) Failure To Properly Evaluate And Choose Your Team Of
Professionals:
This is perhaps one of the toughest things for the real estate investor and
small business owner to do. Part of the problem is that most of these
professionals (e.g., attorneys and accountants) will know more than the
average business owner regarding legal and tax issues. Sometimes the big
mahogany desk and the plush office will make them seem even smarter! Take it
from me, ‘ivory tower’ law and accounting programs really don’t teach
you how to run an LLC for maximum tax savings and asset protection. It seems
to be a lost art these days! The truth is that the competency of legal and
tax services can range from great to very poor! You need to be able to
evaluate this for yourself!
The challenge is that most people who contact an attorney or accountant
rarely have a true two-sided discussion! After all, it’s nearly impossible
to ask the right questions and comprehend all your of options unless you
fully understand the choices and variations available. The Answer: Educate
Yourself First! One thing that I have learned over the years is this: no one
will care as much about your business as you. It may be sad but accept this
today…in fact, right now! Take advantage of top quality home study systems
and detailed instruction. Learn about your options and the ‘best
practices’ for real estate investors and business owners. Seek out those
who want to help and educate! Then when evaluating an attorney or accountant
you can ask them the ‘tough’ questions and see if they can answer or if
they squirm! Doesn’t this sound like a better position to be in? You will
be better able to choose your team and you can ensure that the person who
cares the most about your business can make informed decisions about the
business!
