Limited Liability Companies are Oft Misunderstood

LLCs – or limited liability companies. They’re everywhere you look.  Chances are you own one, work for one, or at least patronized one in the last week. Yet the ubiquitous LLC is understood by few.

An LLC is a type of business entity, just like a corporation. And just like a corporation, it has limited liability aspects, meaning that if the business fails, its investors cannot be held liable beyond their investment in the company. That is, of course, assuming no fraud or other corporate misdeeds.

Once formed, an LLC, like a corporation, is considered a person in many respects. No, it does not get to vote, but it does have some rights under our federal Constitution. For example, corporations are entitled to free speech. Yes, corporations get to speak. They usually speak in the form of advertising, or by donating money to political candidates (which is a whole different subject). They also can sue and can be sued.  

Because an LLC is a person separate from its members (yes, members, not shareholders – I’ll cover this later), it is an excellent way for its promoter(s) to separate personal and business affairs, and limit personal exposure to business debts. In other words, if the business gets sued, the business owner’s personal assets are not at risk. It works the other way too, if the promoter is sued, the business assets are shielded from the promoter’s creditors.  

Be careful though, if the lines between the business and personal aren’t respected, the corporate “veil” can be pierced, and the LLC’s promoter(s) can be personally liable for company debt.    

While an LLC is similar to a corporation in some ways, it is different in others. One difference is that LLCs do not have shares of stock. The owners are called members, rather than shareholders, and rather than have stock shares, they have a “membership interest” in the company.  

Like a country club, the LLC is not required to recognize someone it does not want as a member. This is why the LLC is the entity of choice for protecting assets from creditors. Shares in a corporation can be taken (and more easily transferred). But an LLC membership interest cannot be taken. It can only be “charged,” or garnished. In a small family-run company, should one member’s interest be charged by a creditor, the company can vote against distributing profits. This renders the creditor’s interest in the company virtually worthless.  

Another advantage of an LLC is that its assets are off limits from its members’ creditors. While a member’s share of profits can be garnished (assuming there are profits, and profits are distributed to LLC members), the LLC’s real and personal property cannot be taken. The only time the LLC’s assets can be taken is if the LLC itself is liable.    

LLCs offer tax advantages too. They are ordinarily taxed like a partnership, but the members can elect to have it taxed as a corporation instead. This flexibility in how the entity is taxed is a significant advantage over a corporation.    

Businesses are not the only folks who form LLCs.  Extended families that own real property together often use LLCs to hold real property, rather than own it directly. Structuring the ownership this way helps enforce use and upkeep rules between family members. It also can restrict family members from transferring their interest to anyone but another family member (and protect the property from claims by creditors or ex-spouses).  

That is not to say that every asset should be owned by an LLC. Titling an asset in an LLC may cause it to be deemed “commercial property,” which can negate certain tax advantages and exemptions that apply to a residential property.  

There is risk too.  An LLC is a creature of contract, meaning that its operation and management (and even dissolution) are dictated completely by the terms of an operating agreement. LLCs lacking an operating agreement – or that have a poorly drafted operating agreement – can cause problems for its members. For example, without an operating agreement, LLC members may not withdraw unless the other members agree. This can allow one member to hold another member hostage if the terms of a dissolution cannot be agreed.

While there is no silver bullet that can protect against each and every risk, structuring a business or shared asset inside an LLC offers significant advantages for both protecting and managing the business or asset.  More information about LLCs is available on the Washington Secretary of State’s website www.sos.wa.gov.