You’ve got the great idea. You drafted the business plan. You used a lawyer to set up your business as a limited liability company (LLC). Now what?
With resources–and legal resources in particular–so readily available today, a hungry entrepreneur might pay a few hundred dollars to set up his or her business entity and get straight to work. And while the product or service is of primary concern when starting a business, skipping the important legal steps in the beginning could create problems down the road. It is important to ensure you finalize the creation of and maintain your legal entity in order to save future headaches. And getting a filed copy of the Articles of Organization is not the end of it. There are several issues to consider when preparing your LLC documents and once you have the filed copies.
Member-Managed or Manager-Managed LLCs
An LLC can be managed by a manager or by its members. A member-managed LLC is run by all of the members of the LLC (members of an LLC are like shareholders of a corporation). All the members are agents of the LLC and all members can vote on business decisions. A manager-managed LLC is run by one or more managers. A manager can be a member of the LLC but does not have to be. In many states, a manager can also be another entity, such as a corporation or LLC. Typically, a startup will be member-managed, as there are only a few people involved and all members have authority to act on behalf of the business. The simple structure makes it easy to run the business. However, if your plan is not to involve all members in the decision-making process and and not everyone will have the authority to act, you want to consider a manager-managed LLC. A manager-managed LLC may also be useful if you have passive investors involved in your business.
The Operating Agreement
If you have already set up your LLC, you should have a fully-executed operating agreement. The operating agreement will include information about whether the LLC is member- or manager-managed, and it will provide details about how management can run the business. Managers often have fiduciary duties, or heightened responsibility, in managing the business, so if you want this kind of responsibility in a member-managed LLC, you need to ensure the operating agreement provides as much. Some important features that should be part of your operating agreement include:
1. Details about initial and future contributions by members;
2. Rules for admitting new members;
3. Who is managing the company (manager(s) or members and list who they are) and what rules and processes they must abide by, such as voting, maintenance of company records, and election and removal of managers;
4. Allocation of profits and losses, usually prorated based on your percentage interests. For example, if Jane puts in 70% of the initial capital and Susie puts in 30% and they are 70/30 owners based on this, Jane will get 70% of the net profits and be responsible for 70% of net losses;
You also may want to consider a mandatory buyout section which allows for members to buy out another member upon the occurrence of certain events (death, divorce, or bankruptcy) in order to avoid tying up your company in probate, family, or bankruptcy court.
Capital Accounts and Distributions
If you’ve read the legal mumbo jumbo in your operating agreement, you probably noticed that it mentions capital accounts and distributions. A capital account is not an actual bank account. They are an accounting on the books and records of the LLC which track the initial capital each member provides to the company for his or her membership interest. Capital contributions can be cash or property. If it is property, such as a physical work space, or more commonly, intellectual property, the members should agree on the fair market value of the property in order to credit that member’s capital account for his or her contribution.
Members do not need to contribute loads of initial capital. It should be enough to cover initial expenses until the company’s revenue can pay for expenses. Your operating agreement should include details about whether and how additional capital can be contributed.
Distributions can be made pro rata based on members’ capital contributions or they can be made in another way. It is important that your operating agreement include an exhibit with capital percentages as well as income/loss distribution percentages as agreed upon by the members.
Maintaining Corporate Formalities
Now that you’ve got your legal “T”s crossed and “I”s dotted, you can get to work. But don’t forget about maintaining your LLC. Generally, states require you to file an annual statement of information. If your legal entity is registered in a state other than the one in which you operate, you need to have a registered agent for service of process and a foreign LLC filed in the state(s) in which you operate. It is also vital to maintain your books and records, keep your LLC bank account and money out of your personal accounts, and draft member minutes when voting on business decisions. These maintenance issues may be annoying to an entrepreneur who has enough on her plate, but having a clean and organized company when it’s time to get funding can be a major factor in securing that funding, and, perhaps more importantly, it can shield you from personal liability if the business fails or falls into a nasty lawsuit. Using a business attorney to keep your business up to date is a great way to minimize your risks. After all, you set up your LLC for a reason, didn’t you?