LLC_Business_5 Biggest Mistakes

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The 5 Biggest Mistakes Made by an LLC Business

Mistake #1

Before the LLC Business Entity is Formed, Don't Conduct Business

An LLC business cannot do business before it is formed. Accordingly, you are personally liable for any "LLC" business activities or transactions that take place before your LLC business entity is formed. If your LLC business becomes successful, those early acts performed prior to the formation of your LLC business entity could cause you to be the subject of a personal lawsuit. Don't think it has not been done. A person can sue you years later for something you did today. With over 70,000 lawsuits filed a day, this world is filled with people and their predatory litigation attorneys looking for successful small businesses to attack.

Many new business owners put off the formation of their LLC business while they work on the other details of starting a business. Once you have decided to start a business, it is a much smarter move to form your LLC business entity at once and then have the LLC itself engage in the other start up activities as opposed to you personally. This is the best way to ensure your liability protection- an LLC business entity formed as early as possible.

Another mistake many business owners make is thinking that once their formation documents have been sent into the state agency, their LLC business entity has been formed. This may be wrong! In many states, an LLC is not formed until the state agency has processed the paperwork and entered the new LLC business entity into the official LLC database. This process can take as long as 30 days or more in some states. The Certificate of Organization is the birth certificate of the LLC business entity and you should wait until you have received this before you engage in LLC activities.

Now, if you have found that you waited too long and you now need to open a bank account to conduct business or your business needs to sign a contract, hire an employee or otherwise conduct business, most states offer expedited services to form an LLC business entity. The expedite services usually requires the filing of an additional document and paying an expedite fee in addition to the filing fee they charge for the filing itself. In most states, you can have your LLC business entity formed in 3 business days but it will cost you significantly more.

In summary, once you have decided to start a business, move forward to create an LLC business entity right away. This will ensure you have more liability protection and it will save you the money and stress of having to form one on an expedited basis to avoid losing business or delaying other start up activities.

Mistake #2

Failing to Actually Issue Ownership Interests of the LLC Business Entity

Many business owners create an LLC business entity but never actually issue ownership interests (known as Membership Units) to the persons that are going to be owners of the LLC (known as Members). It can be easy for you mistakenly think that because you created the LLC business entity, you are automatically the owner of the LLC.

The fundamental premise of an LLC is that it is its own separate entity. When an LLC business entity is formed by a state agency, it does not have owners. Membership Units or a percentage interest in the LLC must be issued to the persons who will be the owners. This issuance transaction needs to be in writing.

The LLC Operating Agreement is the typical place where the LLC business entity issues shares to Members and usually the Members agree to contribute a certain amount of money to the LLC for those Membership Units (this money obligation is known as a Capital Contribution).

Make sure that after your LLC is formed, you complete this next step. It is vital to your LLC business because an LLC once formed is a shell entity without any ownership attributes until Membership Units are issued to Members.

Mistake #3

Failing to Create a Management Structure and Appoint Officers for the LLC Business Entity

An LLC business entity needs to have a management structure. A management structure determines who has the authority to make decisions on behalf of the LLC. There are two management structures. A member-managed LLC is when the members automatically have the rights to operate and manage the LLC business. The second is a manager-managed LLC which creates a corporate type structure. A Board of Managers is created and persons who are appointed to that Board have the authority to run the business. All LLC business entities should appoint the officers (President, Secretary, Treasurer) of the LLC.

The best place to create a management structure and appoint initial officers is in the LLC's Operating Agreement. Every LLC business entity should have an Operating Agreement as this agreement creates the set of rules for your LLC. If you are a single member LLC, this becomes even more important because you run a higher risk of losing liability protection if you ignore your entity as a separate entity.

Remember, your LLC is a separate and distinct entity and this is important to preserve the layer of limited liability protection afforded by an LLC business. If you do not comply with the standard protocols for an LLC business, a predatory attorney can try to sue you personally and say that you should be personally liable for the LLC activities because you did not treat the LLC as an entity separate and apart from yourself.

Now, the LLC Acts of most states will have default management provisions that apply if your LLC business does not have an Operating Agreement, but those laws are always changing and they can be difficult to apply. Plus, if you have other Members, then disputes can arise as to what voting requirements, profit allocations and other rules apply. The laws may include provisions that you do not want for your LLC. Another great benefit of an LLC business entity is that the Members can decide amongst themselves how they operate their LLC. Use a well drafted Operating Agreement for your LLC and get all of your Members to sign the Operating Agreement.

Mistake #4

Failure to Get Investment Obligations in Writing

The LLC Acts of most states require that all agreements by a Member of an LLC business to contribute money to the LLC must be in writing. An oral agreement is not enforceable under the law.

If you are planning on starting a new LLC business with other persons, you will likely get together and decide on how much of the business each of you will own and on what obligations each of you are agreeing to with respect to that business. Obligations usually include how much money you are each going to contribute to the LLC business and what kind of services and time commitment each of you will devote to the LLC business.

At the beginning of a business, these conversations take place and everyone agrees. An important discussion is how much will the LLC business require in money before it can generate its own cash to operate the business. This amount is known as start-up capital.

A typical conversation between owners of an LLC business goes like this:

Anne: "John, we are going to need $20,000 over the next year to start this business. If we are going to each work equally and you agree to put in $ 5,000 of the capital, I agree to issue to you 25% of the ownership of the business."

John: "Anne, that sounds fair. We will each work equally in the business but because you will be contributing $15,000 and I will contribute only $5,000, the 75%-25% allocation makes sense. Now, I am looking at our budget and most of the money will not be required until 5 months from now when we will move into office space and need to pay our vendors for products purchased- I will contribute my $5,000 then- is that okay?"

Anne: "Sure, as long as we are in agreement as to amount, I can front the initial expenses until the 5th month and then the LLC will need your $5,000."

Then John and Anne form their LLC and starts their business. . . forgetting to ever document the agreement among LLC owners (known as Members) in any written agreement. Five months later, Anne asks John to contribute $5,000 and he says he does not feel like he should contribute this money because he has worked more on the business than Anne or. . . perhaps he decided to invest the money elsewhere at that point.

This is a common situation that owners of a multi-member LLC business find themselves in often. Any monetary or services obligations should be set forth in writing.

Mistake #5

Thinking that an LLC Business is a Foolproof Layer of Liability Protection

Yes, it is established that a Member of a properly formed and maintained LLC business is not liable for the debts, obligations and lawsuits of the LLC merely by being a Member of the LLC. But, in a realistic business context, persons who are Members are usually not passive owners of the LLC. They are also active managers and operators of the LLC business.

In today's litigious world, all businesses should be run through a limited liability entity such as an LLC. The LLC liability protection is a significant protection vehicle. However, the LLC layer of protection does not extend to all potential liabilities that can arise in the midst of running an LLC business.

For example, you may be in a company car driving to see a client when you are in an accident. You will be personally liable for that accident regardless of the fact that, at the time, you were working on behalf of your LLC business. The LLC laws do not cover personal negligence. Your LLC business entity should always have insurance to cover these types of business related accidents. Do not ever think that the LLC is enough to protect you in these circumstances.

Similarly, there are some laws that hold you liable regardless of whether you are operating through an LLC business entity. The most obvious one that might apply is if you are a licensed professional. Doctors, lawyers, accountants, real estate brokers and dentists, for example, are always personally liable for acts of malpractice. If you are a licensed professional, make sure you get the proper insurance.

Also, there are certain tax, environmental and securities laws that you can be held personally liable for if your LLC business is in violation of those laws and you were the responsible manager. Do your homework in performing the administrative and other tasks of your LLC business entity and retain the proper professionals to advise you when appropriate.

Finally, you cannot use your LLC to engage in fraud or hide behind the LLC business entity to protect yourself when you engage in fraudulent or unlawful acts. If you break the law or try to defraud others, the law will hold you personally accountable.

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In summary, the LLC business entity is a wonderful vehicle for providing Members with limited liability protection. But, in order to preserve that protection, you cannot just form an LLC business entity and then forget it exists. Make sure you do the necessary things to honor your LLC as a separate entity and also know that the LLC should not be your sole means of protection- get insurance when it makes sense and always invest in the required knowledge for operating your business which includes getting the right help when needed in your LLC business!

Forming an LLC

LLC Operating Agreement

LLC Information at LLC Learning Center

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