When forming a new business, a founder must make several important decisions upfront including what type of legal entity to select. Choosing the appropriate legal structure requires consideration of issues such as ownership structure, liability, profit distributions, tax treatment and capital raising, to name a few.
Many businesses are attracted to the limited liability company (LLC) structure because it offers the flexibility and tax benefits of a partnership with the liability protection of a corporation. An LLC also has less record keeping requirements compared to a corporation. Assuming you choose this popular form of business entity for your own company, there will be several steps to take and issues to consider when forming your LLC.
- Select the State of Formation: Although Delaware is a common choice for LLC formation, there may be other more compelling reasons for organizing your entity in a different state, including certain business, tax, social, or policy considerations. For example, forming an LLC in an organizer’s home state is often the easiest and can be the most cost-effective option, especially if the LLC will primarily conduct business in that state.
- Choose the Company Name: Make sure your chosen name is available for use in all states where the LLC must ultimately register to do business. Also, most states have specific statutory requirements for an LLC’s legal name that you will need to consider. For example, the name will likely need to have “LLC” or “L.L.C.” included in it. Last, if you plan to use the LLC name as a trademark, service mark, or domain name, it is highly advisable to conduct a more formal trademark and domain name search prior to forming your entity. Otherwise, you assume the risk that the mark or domain name may already be taken, in which case, you may be forced to use a different name and incur the cost and hassle of having to amend the LLC’s name on the formation documents and change the LLC name anywhere else it may exist (like on your website).
- Create the Certificate of Formation: Every LLC will need a Certificate of Formation, which is sometimes called the Articles of Organization depending on the state of formation. This document is akin to a corporation’s Articles of Incorporation and is filed with the Secretary of State’s office. Templated forms of the certificate or articles are available on almost all Secretary of States’ websites, although using these forms is not mandatory. Because each state’s requirements are different, pay close attention to the requirements of your chosen state. For example, you will need to designate a registered office and a registered agent (which may be a professional registered agent) and list them in your certificate or articles. You may also elect to include certain matters such as limiting the authority of managers or members or limiting the duration of the LLC’s existence. With respect to filing, you may file the certificate or articles either directly with the Secretary of State or through a service company; in either case, you will of course need to pay filing fees. Again, pay attention to each state’s requirements, as some states will require original signatures, while others may accept a fax/electronic copy.
- Create the LLC Operating Agreement: If the LLC will have more than one member, then it should have an Operating Agreement signed by all of the members. An Operating Agreement should be specifically tailored to the business or service, as well as to the particular composition of its membership. Think of the Operating Agreement as a combination of corporate bylaws that guide the governance of a corporation and a stockholder agreement that dictates the rights of the shareholders. When drafting the Operating Agreement, you will need to consider matters such as the management of the LLC (e.g., manager-managed or member-managed), the rights of members (including whether or not there will be different classes of membership interests), capital contributions, allocation of profits, losses and distributions, the death or disability of a member or manager, and the dissolution and winding up of the LLC.
- Adopt Initial Acts of the Members or Managers: Although not required, adopting initial resolutions of the members or managers of the LLC is good practice. New LLCs should consider passing resolutions which ratify all formation activity, including filing for foreign qualifications, designating the LLC’s fiscal year, opening bank accounts and designating signature authorization.
- Prepare the LLC Minute Book: While a minute book is typically a corporate item, maintaining a minute book for your LLC will keep your formation and critical LLC documents organized and in one place. Keep copies of the certificate of formation, operating agreement, resolutions, amendments and other important documents such as the EIN (discussed below), and tax filings in the minute book.
- Apply for an Employer Identification Number (EIN): If you need an EIN after you’ve formed your LLC, you can obtain one by filing an IRS Form SS-4. When you receive the EIN letter from the IRS, make several copies and keep one in the minute book. Trust me, you do not want to deal with the hassle of obtaining evidence of the EIN from the IRS at a later date.
- Other Items to Consider: Depending on the type of business or service being offered by the LLC and the number of members involved, there will of course be other issues to consider or address when forming an LLC. For example, does the LLC need to apply for any state- or county-specific licenses? Does the LLC need foreign qualifications? Have all of the LLC’s members been represented by separate counsel or advised to have separate counsel in connection with the Operating Agreement? Have you reviewed all specific statutory requirements for this LLC and its business or service? Do you want or need to make any special tax elections after forming the LLC? Do you need special insurance in addition to the mandatory state required insurance?
By carefully considering the above issues, you will be well-positioned to launch your new LLC. It is worth noting that once you’ve formed the LLC, you will need to ensure it remains an active entity, in good-standing, by filing certain state reports each year. Outside GC has advised many start-up businesses on choice of entity matters and regularly helps clients with on-going entity governance. If you have questions about LLCs or entity formation, please contact Amy Jeffrey at email@example.com or 970-390-5997.
Amy Boatner Jeffrey is seasoned business attorney with over twenty years of transactional experience representing clients in various sectors and industries, including banking/finance, healthcare, life sciences, medical device, real estate, and commercial aviation. She also serves as Managing Member for Outside GC LLC and its sister organization, Patent GC LLC.