Limited Liability Companies
Limited Liability Companies, or LLCs, are one of the fastest growing types of new business organizations. The majority of businesses represented by Harshman Ponist are organized as LLCs, making it a structure we know exceptionally well.
Limited liability companies can be organized in any state, and each LLC is governed by the statutes of the state in which it is organized. In Indiana, LLCs are governed by the Indiana Business Flexibility Act. All LLC statutes have certain fundamental aspects in common, such as the limitation of liability for owners (known as members in LLCs). However, the statutes vary significantly from state to state in important details. The information provided on this page pertains to LLCs organized in Indiana and may or may not apply to those organized in other states.
A limited liability company is often viewed as a hybrid between a corporation and a partnership. Like a partnership, forming and operating a limited liability company is relatively simple, with few required formalities. Like a corporation, the owners of an LLC are generally protected from personal liability for the debts and obligations of the business.
An LLC is often a good choice for a small, startup business because it offers flexibility on many fronts, most notably taxation. An LLC that has one owner can be taxed as a “disregarded entity” (similar to a sole proprietorship), as corporations under Subchapter S, or as a corporation under Subchapter S. LLCs taxed as disregarded entities, partnerships, or Subchapter S corporations do not pay income tax. Instead, the LLC’s income, gain, losses, and other tax items are passed through to the owners, which means they pay income tax on the LLC’s income (even if the LLC does not distribute the cash to the owners). LLCs taxed as Subchapter C corporations pay tax on their income, and then the owners pay tax on any cash that is distributed from the LLC to the owners (creating so-called “double taxation”).
Additionally, . LLC offers choices in management structure. It can be organized as a member-managed LLC or a manager-managed LLC. As the name suggests, the members directly manage a member-managed LLC, in much the same way sole proprietorships or many general partnerships are managed. In a manager-managed LLC, an individual is appointed with the authority to autonomously manage the company. This is a good choice for members who do not want to be actively involved in the day-to-day business operations, but it offers other benefits as well. For example, a sole business owner may choose to set up a manager-managed LLC and name herself as manager. That gives her the option to later assign the management responsibilities to someone else, or to name an alternative manager to take over the operations when she is unavailable or incapacitated.
When it comes to transferring ownership of a business, LLCs are more like partnerships than corporations. A corporate stockholder has both economic rights (the right to receive dividends) and voting rights. Generally, the stockholder is free to sell the stock to anyone he or she pleases, and the buyer acquires the same voting and economic rights that seller had. LLCs, like partnerships, are different because economic rights (the right to receive distributions of cash, called interest) and voting rights are separate. The Business Flexibility Act permits a person who owns LLC interest to sell it, but the buyer does not acquire voting rights by merely acquiring interest. Voting rights are acquired by being “admitted” as a member of the LLC, which generally requires the approval of all the other members. However, the members of an LLC may adopt different rules by creating an “operating agreement.”
LLCs also differ from corporations by providing the benefit of what is termed “charging order protection.” If the shareholders of a corporation have outstanding debts to creditors, a court-issued judgment may be levied against their stock, forcing the stock to be sold to their creditor. This often results in the creditor effectively becoming a new shareholder in the corporation. In contrast, the creditors of members of an LLC are generally limited to obtaining a “charging order,” which is a court order instructing the LLC to pay to the creditor any distributions that would otherwise go to the member. It is similar to the garnishment of wages, and most importantly the creditor does not receive any voting rights. Although the law is still evolving and some uncertainties remain (particularly with respect to LLCs with only one member), the exclusivity of a charging order is an important advantage held by members of an LLC that is not available to shareholders of a corporation.
These are just some of the reasons we often advise our clients that a limited liability company is the best way to organize their business.
If you're starting up a new business -- or have an existing business and want to review its organization -- please consider making an appointment with us to discuss the best structure for you.