How Does a Limited Liability Company Work?

By Rob Jennings J.D.

Limited liability companies (LLCs) are becoming increasingly popular as business entities that provide the limited liability advantages of corporations without the double taxation and all the formalities. While an LLC is frequently cast as a quick and easy alternative to incorporation and a safe alternative to sole proprietorship or partnership, before starting an LLC an entrepreneur should understand how the form works.

Limited liability companies (LLCs) are becoming increasingly popular as business entities that provide the limited liability advantages of corporations without the double taxation and all the formalities. While an LLC is frequently cast as a quick and easy alternative to incorporation and a safe alternative to sole proprietorship or partnership, before starting an LLC an entrepreneur should understand how the form works.

The Articles of Organization

Just as a corporation has a charter, an LLC has its articles of organization. The articles establish the legal existence of the company as a separate entity and contain important information about the enterprise such as the owners, the managers, a registered agent for service of process, and the address of the company. Most important, however, the articles of organization describe the business itself, the company's reason for being. Since stepping outside the articles' description of the business can lead to a loss of limited liability, members will frequently describe the business as "to engage in any lawful activity" or something similarly broad in order to avoid the undue restriction of business activities.

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The Operating Agreement

Although an operating agreement is not a legal requirement in every state, having one is crucial to the smooth and effective operation of the business. An operating agreement governs the rights and responsibilities of LLC members. Members' percentage of ownership, capital contribution requirements, transfer of interests and the dissolution of the company are all issues commonly covered by operating agreements. These documents not only strengthen the limited liability function of the LLC, but they promote efficient business by resolving potential issues that might cause members to disagree later on.

Transfer of Interests

The operating agreement will contain provisions governing how members are to be added or removed and how members can transfer the interest they hold in the LLC. Many agreements will restrict the transfer of membership interests to other parties without the approval of remaining members, as LLCs are frequently closely-held corporations owned and operated by a small group of people who are familiar with one another. Involuntary transfer provisions of an operating agreement govern the forced transfer of membership interests upon the occurrence of certain events, such as a member's filing for bankruptcy or the dissolution of a member's marriage.

Dissolving an LLC

Whereas a partnership or sole proprietorship can cease operating relatively simply, an LLC presents more complicated issues. State law governs the dissolution of LLCs and the liabilities of members when the business comes to an end. The operating agreement will spell out how the company's assets are to be distributed among the members, how capital contributions are to be returned, and how the members are to be compensated for any of the company's debts that they personally guaranteed.

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Reasons for Voluntary Dissolution of LLC

References

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