Limited liability is crucial when running a business—in fact, it may be one of the most important tools that a business owner can use to minimize risk. If a business is properly structured, then the only assets that should generally be at risk are its capital. But if the business is not properly structured, then all of your assets are being placed at risk.
So how do you protect yourself? The most common entity that is formed for startups is the limited liability company (LLC). First brought to the US by the State of Wyoming in 1977, LLCs are now available in all 50 states. They are a flexible tool that can provide the best of both worlds: limited liability for the owners (members) of the LLC and “pass-through” taxation that allows the members to pay the taxes on earnings of the LLC on their personal returns.
In New York, LLCs are established by filing Articles of Organization with the Department of State. The Articles usually include a few paragraphs reciting the name of the LLC, the county of establishment and an address where legal papers can be served. That is a public document. Once created, the members employ an Operating Agreement to govern how the LLC will be run. This document is not filed with the Secretary of State and can remain private. Among the matters generally covered by an Operating Agreement are governance, allocation of profits and losses, and membership.
The good news is that LLCs have far fewer ongoing formalities than corporations, which require by-laws, share certificates, annual shareholder meetings and periodic board meetings with written minutes. Nonetheless, even for small LLCs, following best practices in LLC governance is important to maintaining limited liability. Here are some suggested tips:
When used properly, LLCs can be a key tool in protecting your personal assets from business liabilities while providing favorable tax treatment. That’s a win-win scenario every business owner should embrace.
So how do you protect yourself? The most common entity that is formed for startups is the limited liability company (LLC). First brought to the US by the State of Wyoming in 1977, LLCs are now available in all 50 states. They are a flexible tool that can provide the best of both worlds: limited liability for the owners (members) of the LLC and “pass-through” taxation that allows the members to pay the taxes on earnings of the LLC on their personal returns.
In New York, LLCs are established by filing Articles of Organization with the Department of State. The Articles usually include a few paragraphs reciting the name of the LLC, the county of establishment and an address where legal papers can be served. That is a public document. Once created, the members employ an Operating Agreement to govern how the LLC will be run. This document is not filed with the Secretary of State and can remain private. Among the matters generally covered by an Operating Agreement are governance, allocation of profits and losses, and membership.
The good news is that LLCs have far fewer ongoing formalities than corporations, which require by-laws, share certificates, annual shareholder meetings and periodic board meetings with written minutes. Nonetheless, even for small LLCs, following best practices in LLC governance is important to maintaining limited liability. Here are some suggested tips:
- Enter into an Operating Agreement as soon as possible after establishing the LLC. Even a single-owner LLC should have one.
- Never co-mingle LLC funds and personal funds. Establish a business account for your LLC immediately upon formation and use that to pay all business expenses. If a business owner (or employee) spends personal funds on LLC business, the owner or employee should invoice the LLC and be reimbursed from the business account.
- Establish a corporate minute book where all corporate documents are kept in one place. No need to buy anything fancy from a stationery store; a simple binder (or electronic folder) is fine. In New York, there is also no need to buy an expensive corporate seal.
- For initial LLC expenses (such as filing fees and legal work) where the use of personal funds by a founder is necessary because there is no LLC yet, the founder should keep written records of the amounts spent. Once the LLC is created and the account is funded, the founder can submit an invoice detailing the expenses and obtain reimbursement from the LLC business account. A resolution of the LLC should be prepared stating that these initial expenses were incurred on behalf of, and were in the best interest of, the LLC.
- Any financial contributions by the members to the LLC or financial distributions by the LLC to its members should be documented by the LLC. A simple resolution of the LLC memorializing the contribution or distribution should be prepared for each transaction.
- Finally, LLC documents should be send in one's corporate capacity, not individually. For example, signature lines should state Jane Doe, President of XYZ, LLC, not Jane Doe alone.
When used properly, LLCs can be a key tool in protecting your personal assets from business liabilities while providing favorable tax treatment. That’s a win-win scenario every business owner should embrace.
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