Benefits of Forming a Limited Liability Company

Limited liability companies, or LLCs, are the most modern form of business entity. Consequently, LLCs provide their members with several benefits that are not found in older business entity forms, such as corporations or partnerships. These benefits include:

• Limited liability, which protects the personal assets, such as a personal bank account or house, of the LLC member;
• Pass-through taxation, which passes all profits and losses through to the individual member’s personal income tax returns;
• The ability to obtain a state tax ID or federal employment identification number (FEIN), which are often required to open a business bank account or to contract with third parties, such as vendors and distributors;
• Fewer corporate formalities, such as yearly meetings, meeting minutes, and annual requirements imposed by the state;
• An almost unlimited ability to creatively structure the operation of business, whether by managers or members; and
• Fewer restrictions on number of members.

LLCs may have some disadvantages, however. Venture capitalists and other investors often favor corporations over LLCs so that they can easily obtain preferred stock. Depending on the state, filing for an LLC may also be expensive. California requires that all LLCs pay a yearly franchise tax of at least $800, while Illinois charges $500 to file an LLC’s Articles of Organization with the state. Finally, unlike corporate case law, which has been gradually evolving over the years, there is less case law precedent concerning LLCs, which may create uncertainty depending on the facts of the dispute.

Overall, LLCs are typically the favored entity for a small business or startup. If you would like to know what form of business entity is right for you, contact one of our expert attorneys today.

LLC Formation in Michigan: What You Need to Know

Forming an LLC in Michigan is governed by the Michigan Limited Liability Company Act, MCL § 450.4101 et seq. To form an LLC in Michigan, the organizer must file Articles of Organization with the Michigan Department of Licensing and Regulatory Affairs (LARA) and pay the applicable filing fee. As of the date of this post, Michigan charges $50 for LLC formation, which is among the more affordable filing fees in the country.

The Articles of Organization must include the LLC’s name, which must contain the words “Limited Liability Company,” “L.L.C.,” or “LLC”; the address of the LLC’s registered office and the name of its registered agent; and, if the LLC is to be managed by managers rather than members, a statement to that effect. The LLC’s name must be distinguishable from the names of other business entities registered with LARA.

The LLC Operating Agreement: Why It Matters

Perhaps the most important document in the life of an LLC is the operating agreement. Michigan law does not require an LLC to have a written operating agreement—but every LLC with more than one member absolutely should. An LLC operating agreement is the internal governance document that defines the rights and obligations of the LLC’s members. Without a written operating agreement, disputes among members are resolved by reference to Michigan’s default LLC statute, which may not reflect the actual intentions of the parties.

A comprehensive LLC operating agreement should address:

• Membership interests: The percentage ownership of each member and the initial capital contributions made by each member in exchange for their interest.
• Profit and loss allocation: How profits and losses are allocated among members, which may or may not be proportional to ownership percentages.
• Distributions: When and how cash distributions are made to members, and whether members have a right to demand distributions.
• Management structure: Whether the LLC is member-managed (all members participate in management) or manager-managed (management is delegated to one or more designated managers who may or may not be members).
• Voting rights: What decisions require a vote of the members, what constitutes a quorum, and what vote threshold is required for different types of decisions.
• Transfer restrictions: Restrictions on the transfer of membership interests to outside parties, including rights of first refusal in favor of existing members.
• Buyout provisions: Procedures for buying out a departing member’s interest, including the valuation mechanism and payment terms.
• Dissolution: The events that trigger dissolution of the LLC and the procedures for winding up its affairs.

LLC Taxation: Pass-Through vs. Corporate Taxation

One of the most significant benefits of an LLC is its flexibility in tax treatment. By default, a single-member LLC is treated as a disregarded entity for federal income tax purposes—meaning the LLC’s income and expenses flow directly to the owner’s personal tax return as if the LLC did not exist. A multi-member LLC is taxed as a partnership by default, with each member reporting their share of the LLC’s income and expenses on their individual return.

Alternatively, an LLC can elect to be taxed as an S-corporation or C-corporation by filing the appropriate election with the IRS. The S-corporation election is particularly popular for LLCs whose members are active in the business because it can reduce self-employment tax liability. However, the optimal tax structure depends on each business’s specific facts and should be evaluated in consultation with both a business attorney and a CPA.

Protecting the LLC’s Liability Shield

An LLC’s liability protection is not absolute. The doctrine of “piercing the corporate veil”—which applies to LLCs as well as corporations under Michigan law—allows creditors to reach the personal assets of LLC members in certain circumstances. Courts are most likely to pierce the veil when members have commingled personal and business funds, failed to maintain the formalities required by the LLC’s operating agreement, used the LLC as an alter ego for personal purposes, or undercapitalized the LLC to the point where it could not meet its reasonably foreseeable obligations.

Maintaining separate bank accounts, keeping accurate records, avoiding personal use of business funds, and ensuring that the LLC is adequately capitalized are the most important steps members can take to preserve the liability shield. Contact the business attorneys at Revision Legal today for guidance on LLC formation, operating agreements, and ongoing compliance.

When to Convert Your LLC to a Corporation

As a business grows and attracts outside investment, there may come a point where converting the LLC to a corporation is the right strategic move. Institutional venture capital funds, in particular, typically require that investee companies be structured as Delaware C-corporations so that they can hold preferred stock with the specific rights and preferences that are standard in venture capital deals. Pass-through taxation, while advantageous for many small businesses, becomes less important as the company grows and reinvests most of its earnings in growth rather than distributing them to owners.

The conversion from LLC to corporation is a significant legal and tax event that requires careful planning. The structure of the conversion, the allocation of equity, the treatment of existing LLC capital accounts, and the tax consequences to each member must all be addressed in the conversion documents. Our business attorneys advise LLC owners on the timing and mechanics of converting to a corporation and handle all aspects of the conversion, including the formation of the new entity, the transfer of assets, and the amendment of outstanding agreements. Contact us today to discuss whether and when conversion makes sense for your business.

Forming an LLC is one of the most important early decisions a business owner will make, and it is a decision that deserves careful legal guidance rather than a DIY filing. The cost of properly forming an LLC with an attorney-drafted operating agreement is a small fraction of the cost of resolving the ownership disputes, tax problems, and liability exposure that arise when the formation is done incorrectly. Contact the business attorneys at Revision Legal today to discuss forming your Michigan LLC.