Pros and Cons of the LLC Entity Choice

I love LLCs because I don’t have to do anything!

While the LLC organizational structure has gained great popularity, and is often the entity of choice for new business owners, the wonderful flexibility of this structure also carries many potential pitfalls. Below is a short list of some of the Pros and Cons of the LLC structure.

Pros of an LLC:

Flexibility:

An LLC is primarily a business entity of contract agreement. Meaning, there are few legal “requirements” and great latitude for the LLC member, or members, to determine how the LLC will operate.

Choice of Taxation:

As previously discussed here, the LLC entity structure allows the members, or managers, to decide how the company will be taxed… pretty cool (for a nerdy lawyer anyways).

Ease of Setup:

Forming an LLC is a simple process that you can do online, get an EIN, and WHAM-O you have a company. Well at least until you read the disadvantages.

Ongoing Management:

With an LLC, the corporate formalities of annual meetings, shareholder meetings, and other requirements are eliminated… at least in theory. This makes it somewhat easier to manage for many small businesses.

Cons of an LLC:

Flexibility:

Many LLC owners have read an article or two online and because of the ease of set-up, fail to understand the importance of the terms and need for an operating agreement. The operating agreement IS the written contract that dictates how the company will operate. Approximately 60-65% of the small companies I meet with fail to have this agreement in place.

Buy Sell Agreement:

Most business partnerships start like a marriage. Great expectations and friendly. Unfortunately, even in the greatest of partnerships, there is ALWAYS a time for a split. Whether it is disagreement, dissolution of the company, retirement, a sale, or death, at some point every business partnership will end. Failing to have the terms of that end worked out ahead of time nearly always results in disaster.

Record Keeping:

Because the law has few requirements, many LLCs start off on a “set it and forget it” mentality. No major decisions are documented and no formal meetings are held, and as a result these failures may help a plaintiff “pierce the corporate veil,” in other words, hold the owners personally liable (kind of defeats the purpose of having a company, right?)

Company Documents Mismanaged:

In most states, several items are required to be kept at the “Principle Place of Business,” and Missouri requires the following:

Current and past lists of each member and manager, and their mailing address

Articles of Organization, and amendments

Federal, State, and local tax returns and reports for last 3 years

Any written operating agreement, all amendments, and any written operating agreements no longer in effect

Financial statements for the last 3 years

Unless in operating agreement: (i) capital contributions; (ii) voting rights on matters; (iii) what events would cause the company to be dissolved (HINT!!! These should be in a written operating agreement)

Copies of any written promise by a member to make a contribution

Copies of written consents by the members to admit any person as a member

Copies of written consents by members to continue the LLC after an event of withdrawal by another member

Copies of any other instruments or documents required to be in writing per the terms of the operating agreement.

Conclusion

The LLC as an entity is a great option for many small businesses and can accomplish the goals of most companies. However, in order to obtain the greatest level of liability protection, it is still important to follow some basic record keeping practices and to properly structure your agreements (then follow them) to protect yourself from liability should your company ever become the subject of a lawsuit.

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