This letter is intended to summarize a business entity called a limited liability company (LLC). The easiest explanation is that a LLC is a mixture of a subchapter S corporation and a limited partnership. The owners are called members rather than shareholders.
A LLC is created pursuant to the Texas Limited Liability Company Act. It has the characteristics and benefits of both a corporation and a limited partnership. A LLC has the benefits of a corporation, in that a LLC can shield its members from personal liability arising from the operation of the business.
A LLC may engage in any lawful business unless the LLC has been organized for a limited purpose set out in its articles of organization or the business is governed by another law which prohibits the entity from doing business as a LLC. A LLC may have the powers of a corporation under the Texas Business Corporations Act.
Its owners or investors are called members rather than shareholders. A membership interest is a personal property interest and it may be evidenced by a membership certificate similar to a stock certificate.
Members, like shareholders in a corporation, do not own any specific property in the LLC; all of the assets in a LLC are owned by and are in the name of the LLC.
The entity may be treated as if it were a partnership for federal income tax purposes. This is a real benefit. A LLC does not have the restrictions which limit the companies and owners who can do business as a subchapter S corporation. For instance, a LLC does not have to meet the restrictions that are applicable to S corporations (e.g., limited to seventy-five shareholders).
Unless it elects to be taxed as a corporation, a LLC itself is not subject to federal corporate income tax because it is taxed in the same manner as a partnership. For this and other reasons, many businesses which have previously elected to form a standard corporation, professional corporation, or limited partnership may choose to operate as a LLC. Please note that under the provisions of the Texas Tax Code, a LLC is subject to state franchise tax.
One of the most significant features of the act is how LLC’s are managed. Many investors have liked the limited partnership form of business because they can invest money in a business and not be liable for the business’ debts or failure. One drawback on a limited partnership is the fact that the limited partners cannot direct the partnership*s day to day affairs and still retain their limited liability.
Now an investor can invest in a LLC and become a member and a manager. As a member and manager, the investor can have direct input and manage the LLC*s day-to-day affairs without assuming personal liability for the company’s debts. Both members and managers are not liable for the LLC’s debts, including but not limited to, a judgment, a decree, or an order of the court against the LLC.
A member of a LLC is not a proper party to a lawsuit by or against the LLC; therefore, a LLC may provide more protection than a corporation.
The articles of organization must specify how the LLC will be managed. The regulations, if adopted, (like a corporation’s bylaws) should state how the LLC will be managed. Regulations may reserve the right to manage the LLC to the members, in whole or in part, or delegate the same to managers. Managers may be given the powers and duties that directors and officers would have in a corporation.
Therefore, a LLC is managed by its officers, managers or members in the same or similar fashion as a corporation is managed by its officers and directors. A LLC does not require its managers to be natural persons. A LLC uses regulations to provide its rules. The regulations may be in writing or may be adopted through usage and custom. A corporation is governed by its bylaws. LLC regulations, although in form may be similar to corporate bylaws, are in substance, more like a partnership agreement.
Managers are elected as defined in the regulations. They do not need to be residents of Texas or members of the LLC. The act also provides that managers may designate one or more persons who are not managers to be officers of the LLC. The officers may be given the powers as stated in the regulations.
A LLC is organized and structured much like a standard Texas corporation. It is formed by the preparation and filing of Articles of Organization by an organizer. This is similar to filing Articles of Incorporation by an incorporator for a Texas corporation.
LLC’s are owned by members as compared to shareholders in a corporation. A member may be any person, which includes:
Members may be divided into one or more classes or groups with differing rights, powers, and duties. They may also have differing voting rights.
The LLC*s articles of organization are filed with the Secretary of State*s office by an organizer. A corporation files articles of incorporation signed by an incorporator. An organizer is the person who signs the articles of organization and files the same with the Secretary of State’s Office. The Articles of organization are similar to Articles of Incorporation and must contain the following:
Articles of organization exclude the following statements which are found in articles of incorporation:
Once the articles are approved by the Secretary of State’s Office, the LLC will be issued a Certificate of Organization which begins the existence of the LLC.
If the LLC decides to reduce the regulations to writing, the members should meet and agree to the regulations.
The managers or the members who have management rights may adopt the regulations for the LLC. The regulations, like a partnership agreement, can contain provisions for the regulation and management of the LLC as long as the same are not inconsistent with law or the articles of organization.
The regulations may include the following:
A LLC’s name must contain the words “Limited Liability Company” or “Limited Company.” The abbreviations of “L.L.C.,” “LLC,” “L.C.,” “LC,” or “Ltd. Co.” are also acceptable.
A LLC may also do business under an assumed name in which case it must file an assumed name certificate.
The LLC’s regulations may specify the manner and procedure for voting by the members. This is similar to the voting rights that shareholders have in a corporation. There may be one or more classes of members and the same applies to voting rights. A LLC may have voting and non-voting members.
The regulations should state the manner in which cash or other assets will be distributed. In the absence of a provision in the regulations, the distribution shall be made on a pro rata basis in accordance with the agreed value of the contributions of each member.
A member may sell or assign his or her membership interest much like stock certificate. The assignment does not give the assignee or purchaser the ability to exercise the rights or powers of a member. An assignment simply entitles the recipient to take the distributions that the assignor was entitled to.
Unless the regulations provide otherwise, one can only become a member of a LLC upon the consent of all the other members in the company.
After a LLC has been organized a person may become a new member pursuant to the terms of the regulations. In the absence of regulations, a person can only become a member of the LLC by unanimous agreement.
LLC’s are required to maintain registered offices and agents like corporations. The registered agent accepts important documents, notices, and filings such as a summons in a lawsuit. A member, manager or non-member/manager may be the registered agent.
The articles of organization and regulations may be amended just as corporations. Established and existing businesses and corporations may be merged into or converted to a LLC, however, this may constitute a dissolution of the corporation for tax purposes, therefore, you should have the decision reviewed by competent tax counsel prior to making the decision.
A LLC may be dissolved as follows:
A LLC may continue its existence based on the consent level as defined in the regulations, or, if not defined in the regulations, by consent of all of the remaining members.
A special factor to consider before forming a LLC is that other states may not recognize a LLC. This concern is being minimized as many states have enacted LLC provisions.
LLC’s are unique and provide some interesting advantages over both corporations and partnerships. As you know, general partners, including a general partner in a limited partnership, have unlimited liability. In the past, when investors and business persons wanted to avoid the double taxation that can occur when one does business as a corporation, they chose partnerships for their tax advantages. Now you can do most of what was done in either a corporation or a partnership by forming a LLC.