Bob is deciding between a limited liability company (“LLC”) and a Corporation (“Inc.”) and he first “does his homework” to see what documents are included with the package. Bob notices the “complete LLC” includes a certificate of formation on file with the Division of Corporations and an internal LLC operating agreement. He may realize that the LLC operating agreement is a private document for Bob’s records showing he owns and manages the company. In contrast, when Bob compares this to the “complete incorporation” package, he notices a different set of internal company documents: minutes, bylaws, unanimous action of directors and stock certificates (but no operating agreement).
The next question is why the apples and oranges? Bob, like many people, is not experienced with the incorporation process. This is new to him. He has his business plan and is ready to start selling products, services or taking title to assets. On the other hand, he sees this first decision between LLC and corporation and immediately hits the wall we call the “paralysis of analysis,” encountering technical legal jargon and wondering what he really needs and what is best suited for him.
Perhaps you are like Bob, in that you too are new to this threshold decision. You have even read about the differences of a corporation and an LLC and have decided upon an LLC, which is the general recommendation to people who are not sure. In essence, an LLC is like a super-charged, updated version of the corporation. It has flexibility, fewer formalities, and more tax election options. The LLC is the Swiss-Army Knife of the entity world. To extend this metaphor, the Delaware LLC is the really big Swiss-Army Knife with all the gadgets. This is because the Delaware LLC is governed under Delaware LLC Act, a law which allows for much more flexibility than any other state’s LLC Act.
The traditional corporation is increasingly becoming more like the “spork” which can do a couple things, but neither optimally. The corporation is designed to be a bit “clunky” because that slowness helps educate stockholders annually on the company activity and give them periodic votes in re-electing management. Generally with an LLC, the management stays in place until it is removed and has more flexibility than a corporate board.
So what are bylaws? The bylaws provide the mechanics of how the stockholders elect the directors, and the directors appoint the officers and how the officers run the company. (The bylaws DO NOT govern the rights of stockholders to transfer their shares, instead that would be a separate document, called a shareholder agreement – more on that below).
So what are the minutes? The minutes in a corporation complete the formal “hand-off” of authority from the incorporator who (1) signs the certificate of incorporation (usually someone in our office) who appoints the initial director and (2) adopts the bylaws. The initial director(s), in turn through the unanimous action of initial director, appoints the initial officers (President, Treasurer and Secretary) and issues the stock certificates, to be signed by the newly minted President and Secretary. WOW that was mouthful. Welcome to the clunky “spork-like” world of corporations. Many small business owners order a corporation and never even sign their minutes because they don’t realize the importance of them. Instead they just file their tax return. However, from a legal perspective, these dance-steps need to be followed to get the full asset-protection limited liability corporate veil to avoid having you viewed as an “alter-ego” of your business. In other words leaving your minutes blank, may strip the protection you think you have when you start a corporation. Failing to follow formalities, including annual stockholder meetings, puts your corporation at risk for a veil piecing law suit.
Does an LLC have dance steps? The LLC does not have all these dance-steps just to get started. As a result, following the corporate formalities is easy and intuitive. Instead in an LLC, the authorized person (someone usually in our office) signs the certificate of formation. Then we send you a letter with a proposed LLC operating agreement that the new members (owners) can sign. The LLC operating agreement sets up the structure and democracy of who owns the company and who runs the company, but it also governs the rights of members to transfer their interests to others, a good way from keeping annoying people or people you don’t like out of your company. You don’t want your business partner to sell his interest to a competitor or his old college roommate. You did not bargain for that.
Not all LLC agreements are created equal. The provisions discussed herein are often not found in competitors’ LLC agreements. As a result, you will not find out you have an inferior LLC agreement until it is too late and you have a problem. Many competitors use a 50-state LLC agreement and just insert Delaware, where another state name would otherwise be. This is not tailored to Delaware, like ours. Additionally our LLC agreement is not “full-of-blanks” because we fill-in the name of the company and the members, leaving you little to do, but sign the document and you are off and running.
In an LLC, you can limit the rights of any transferees to be non-voting passive members until and unless they are admitted as voting members by the other members. In a corporation, you don’t get this bonus feature without a “shareholder agreement” (the shareholder agreement can be ordered separately for an additional fee, but is not part of the complete incorporation, nor do any other incorporators offer a shareholder agreement – to my knowledge).
The other “crystal ball” feature of an LLC operating agreement is it anticipates the demise of the company. It is a prenuptial agreement. Usually companies are “until divorce do part” because the only ship that does not float is a partnership. It’s not a question of whether the partners will have a falling out, it’s a question of when. The LLC operating agreement has mandatory buy-out language and valuation formulas, that make it easier to keep the company operating and out of court, when there are eventually irreconcilable differences between partners.
In conclusion, of course we want Bob’s business to succeed and for Bob’s business to be profitable. It is important to take that first step with an LLC operating agreement. That will get you off in sneakers designed to run a marathon. If you already set-up a corporation, we can assist you with converting that to an LLC with an LLC operating agreement. We suggest you get the LLC (Swiss-Army Knife with all the features), not the corporation (spork). We also suggest you use the best Delaware LLC operating agreement you can find and make sure it has all the features you want, including the right-of-first refusal on transfers and mandatory buy-out provisions. Please use the incnow.com order form to order the Complete LLC package. Good luck!