One of the most important decisions you'll make as an entrepreneur early on is choosing the right business form. Let's talk about limited liability companies or LLCs. LLCs are becoming a very popular business form because of the various benefits associated with operating your company via an LLC. In this lesson, we're going to talk about what an LLC is, some of the benefits for using an LLC for your business, some of the requirements that are necessary to get your LLC started, and then we'll talk about a legal concept called the corporate veil. Let's jump in. What is an LLC? An LLC is a business form that combines the limited liability aspects of a corporation and the pass-through tax treatment of a partnership. It's an hybrid organization that gives you the ability to shield personal assets in the way that a corporation would do and also allows you to not have the entity taxed separately, but have the tax treatment pass through to the owners of the LLC. Now, those two benefits or the essential drivers for the popularity of an LLC. One, because Limited Liability. This allows you to shield your personal assets from being used to satisfy the debts of your business entity. Next, tax treatment. This allows you as an owner of an LLC, to have the profits of the LLC be taxed via your individual tax return. This allows you to not have to pay separate taxes on behalf of the entity itself. Now let's talk about some of the differences between other similar business forms. For example, an S corporation has very similar limited liability and tax benefits. How's an LLC different from an S corporation? First, in terms of the limited liability, an S corporation is limited to only 100 shareholders. Those shareholders can only be individuals or certain tax exempt organizations, and they can only be US organizations or US citizens. No foreign corporations or foreign individuals can be a shareholder in an S corporation. An LLC doesn't have those limitations. An LLC can have any number of members, there could be any type of organization, an LLC can have a corporation or other business form as a member of the LLC, it can also include foreign individuals or foreign corporations as members of an LLC. An LLC has limited liability treatment that pass through tax treatment of an S corporation without the serious limitations than an S corp imposes. Similarly, a limited partnership has that tax shield for personal assets as well as the pass-through tax treatment. However, a limited partnership requires at least one general partner who has ultimate responsibility for the partnership. The general partner in a limited partnership has personal liability for the debts of the partnership. That's not the case with an LLC. An LLC can have many members or it can have one member. Even an LLC of one member, even that one member will still have the shield from personal liability and the pass-through tax treatment. An LLC in terms of the hybrid of shielding personal assets and having the pass-through tax treatment is a very popular vehicle to use because of the limitations and limited partnerships and S corporations for the same benefits. Now, financing. LLCs are a good vehicle use for the reasons we just stated. But as your company matures and you're looking at financing, the corporate form takes on additional importance. LLC is very beneficial to early round investors. That's largely because they can come on as an investment in LLC, have let the favorable tax treatment that comes with an LLC. However, when you're looking at later rounds of funding and you're thinking about venture capital funding, VCs may require you to convert your LLC to a corporation. Because it's typically easier for a VC to gain equity, stocks and those types of things that are attractive to VCs when they're investing in startups. It's difficult to have those types of equity incentives and those types of financing arrangements when dealing with an LLC. Keep in mind, even if you start your business early on as an LLC for all the benefits that come with the tax treatment and the personal limited liability, keep in mind that you may have to eventually convert your LLC into a corporate form, an S Corp or C Corp, in order to attract later rounds of funding. Two basic requirements to get an LLC started. LLCs are typically governed by, at least in the US, state laws. In the US around how to get your LLC started, basically, the two requirements are to file a certificate of formation. This is just a notice, an application to the secretary of state in the state that you're incorporating, or a similar state agency that oversees the formation of LLCs. You file that certificate noting that you're forming an LLC, and then you want to sign an operating agreement. An operating agreement is essentially how you will run the LLC, like how capital will be contributed, how profits and losses will be shared, what happens upon dissolution of the LLC, all of those types of requirements and business operations for the limited liability company will be spelled out in your operating agreement. If you have more than one member of the LLC, more than one owner, then you want to make sure you spell out their respective percentages of capital contributions, profit, loss sharing, and other issues. Now let's talk about this legal term called corporate veil. We've been talking about the idea with an LLC, members of the LLC can shield their personal assets from liability of the LLC. Now, in this depiction, it really illustrates this concept of the shield. In legal terms, we call that shield a corporate veil. What the corporate veil does is it hides the owner's personal assets from the assets of the LLC. If a creditor or a plaintiff in a lawsuit who's suing the LLC, if they are suing the LLC or have a debt with the LLC, they're shielded from going after the personal assets of the individual owners. They can only go after the assets of the LLC. However, this is only the case if the owners of the LLC, respect the corporate form. By respecting the corporate form that means that you must treat the business as a business, and treat your personal assets as your personal assets. If you don't do that, this corporate veil can be pierced. Piercing the corporate veil is a legal term for a court disregarding the corporate form. A court will say, ''Hey, you're not respecting the corporate form. We'll disregard a corporate form, and now this creditor, or this plaintiff in a lawsuit, can not only go after the LLC, but also can go after the individual assets of the LLC's owners." Here's some primary reasons why a court would pierce the corporate veil; the first is alter ego. An alter ego essentially means that the owners of the LLC are essentially using the LLC as a second face. They're conducting personal activities through the LLC. This comes up when you are co-mingling your bank accounts, like your personal bank account and the LLC's bank account are the same. Or you're entering into contracts with vendors and suppliers, sometimes under your personal name, sometimes under the LLC name. These types of activities essentially indicate that the LLC is essentially your second phase, it's your alter ego. In instances like that, if a creditor has a debt with the LLC or plaintiff in a lawsuit, has a lawsuit against the LLC, the court will pierce the corporate veil and allow the creditor or the plaintiff to go after your personal assets. The other reason appears to corporate veil is illegal activity. If you're using an LLC to engage in illegal activity, the court will ignore the corporate form and allow a prosecutor or a creditor to go after you individually in that instance. Best practices for ensuring that the corporate veil is that pierce with respect to your LLC. Whenever you're dealing with vendors or suppliers or other creditors, just be fair. Be fair and follow the law. If you have questions about the legality of your dealings with vendors or suppliers, make sure you consult with counsel. By dealing fairly, you mitigate the opportunities for bad things to happen, you mitigate the likelihood that a plaintiff or a creditor will seek to go after you personally as opposed to just the assets of your LLC. Then you want to make sure you always keep the LLCs business and your personal business separately. Have separate bank accounts, have separate facilities, ensure that it's very clear that the LLC's business is separate from your personal business. You also want to make sure you fund the LRC appropriately. Undercapitalized business is another red flag for courts when you're thinking about piercing the corporate veil. Make sure that the members of the LLC are contributing sufficient capital to actually run the operations of the LLC. Then finally, all business contracts when you're dealing with vendors or suppliers or other third parties, you want to make sure that the members or officers of your company or other employees of your company, that they're signing those contracts in the name of their LLC. They should put their name, their title of your company, and the name of the LLC as the signatory to contracts that are the LLC's contracts. Do not get in the business of signing contracts in your individual capacity, if you want to ensure that a court later won't pierce the corporate veil. In summary, LLCs are very popular vehicle for getting your business off the ground, it provides a favorable tax treatment through taxes, and it also shields members and owners of the LLC from personal liability. To get an LLC started, you typically need to follow certificate of formation with the state in which you're doing business, and then get assign the operating agreement that outlines how the business will be ran. Then keep in mind that failure to maintain the LLC as a separate entity from your personal dealings, can result in the individual owners of the LLC having personal liability for actions of the LLC.
