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Should Your Client Form an LLC?

April 2, 2018, 9:38 am CDT

One of the most important choices an organization will make (or, as their business attorney, you will help them make) when forming a new business is which legal structure to choose: limited liability company, partnership, sole proprietorship, corporation, nonprofit, cooperative, etc. The type of business entity that will ultimately be the right fit will depend on a variety of factors such as liability, taxation, and record keeping. Many early stage small businesses often find that the flexibility and simplicity of a limited liability company (LLC) make it the best choice for them compared to other legal business structures. Here are some reasons why:

LLC advantages

Limited liability

It’s actually part of the name, so limiting the business owners’ liability is obviously a major reason for choosing this business structure. With an LLC, business owners’ personal assets are protected from bankruptcy or litigation – provided there is no gross negligence or criminal activity, of course.

Less paperwork

Compared to corporations and the other types of structures, LLCs generally have less paperwork and less “red tape.” That being said, each LLC should have an operating agreement to create rules that govern their business. Standard documents for those agreements and other LLC paperwork are available through “know-how” resources such as Practical Law® on Thomson Reuters Westlaw™ (see Practical Resources for Setting up LLCs below).

Pass-through taxation

With pass-through taxation, essentially the business income “passes through” the business to the owners, and each member reports their share of profits or losses on their own individual tax returns. This structure assures the members will avoid double taxation that can occur with corporations, where the corporation pays taxes on its income and the shareholders also pay taxes on their dividends. One thing to note, though, is that because there are no dividends with an LLC, members will get taxed on any profits regardless of whether those profits were distributed to the members or reinvested in the business.

LLC limitations

Of course, an LLC is not the perfect solution for every business. It has its limitations. For example, some jurisdictions don’t even allow certain professional groups (lawyers, doctors, accountants, etc.) to operate as an LLC. And since there are no official titles and reporting structures like there are in a corporation, there may be some confusion on roles and responsibilities within an LLC; and by default, an LLC dissolves when a member leaves the organization. However, many of these issues can be addressed and further defined in the operating agreement – all the more reason to have you help your client draft the agreement and other forms.

Practical resources for setting up LLCs

So … what if you determine that setting up an LLC for your client is the way to go, but you’ve never actually done that type of work? There are resources out there to walk you through it. For example, Practical Law® on Thomson Reuters Westlaw provides standard documents, how-to guides, and other resources to help you get up to speed quickly on unfamiliar areas of law. There are thousands of documents related just to LLCs alone. Here’s a sampling of the kinds of state-specific LLC documents available to you:

• Standard documents of LLC agreements, complete with integrated notes containing explanations and drafting and negotiating tips
• Standard clauses related to tag-along and drag-along rights, preemptive rights, call and put rights, buy/sell provisions, key tax provisions, waterfall provisions, etc.
• Practice notes and articles providing guidance for drafting and negotiating LLC agreements
• Checklists summarizing steps to take and issues to consider when forming LLC agreements
• Toolkits with core resources to assist in forming, maintaining, and terminating an LLC

Whichever business structure you and your clients decide best meets their needs, make sure you take full advantage of all the legal resources available to you to help them comply with the applicable jurisdictional regulations and position their organization for future success.

Need to draft an LLC Agreement?

Use this long-form US LLC agreement for an investment transaction with multiple members (such as a private equity buyout). This Standard Document includes integrated notes with important explanations and drafting and negotiating tips. Sign up for your free trial of Practical Law to access the document now!

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