The Series LLC: Not Your Average Business Entity
IncNow President John Legaré Williams recently gave a TEDxWilmington Talk on the series LLC. This is what he discussed.
- The Series LLC allows you to separate your assets
- Many business types can use the Series LLC
- The Delaware Series LLC is a popular choice
I need you to suspend your disbelief just for a second and imagine I am Mick Jagger. I am on a tour playing in small venues across the United States. I’ve just arrived in Wilmington, Delaware, where we’re performing a concert at the sold-out Queen Theater. While they’re serving cold beverages in the back, they’re also serving hot coffee. Someone orders a hot coffee, walks through the crowd, bumps his elbow and drops the cup of coffee on concert goers and staff resulting in minor burns. So, what happens next?
We’re in America, so people get sued. Those with the temporary discomfort of a cup of hot coffee to the skin decide to sue—and sue everyone they can. They sweep the streets. The allegedly injured see dollar signs and decide to sue the artist, the touring company and the Queen Theater venue all as defendants, in addition to the man carrying the coffee. The man carrying the coffee is broke and essentially judgement proof, which is the reason so many get sued. The other defendants who may be indirectly to blame are thought to be wealthier or insured. This makes them attractive targets for the lawsuit.
You may think, “Really, do musicians get sued that often?” There are literally millions of lawsuits filed every year in the United States for all types of problems, whether real, exaggerated, frivolous or laughable. The wealthy deep pockets of business and high net worth individuals including celebrity musicians can be the prime targets. Even Bruce Springsteen decided to call his tour in 1977 the “Lawsuit Tour” after a dispute with his business manager resulted in a protracted lawsuit. In terms of pre-litigation planning, the best time to prepare is before anyone gets hurt. It is best to plan ahead to prepare for these hypothetical judgement creditors, to avoid giving future judgment creditors a windfall. An ounce of prevention is better than a pound of cure. Taking prophylactic measures can make lawsuits less attractive to bring by turning what would have been deep pockets without planning into very shallow pockets with advanced planning. That can make defendants less attractive targets for a lawsuit.
Of course, insurance is also good to purchase. The problem with insurance is when coverage is denied or the amount of coverage is inadequate, excess liability results. Everything the policy gives you in the big print they take away in the small print. Therefore, business organization planning needs to be a primary consideration. It is best to minimize their negative financial impact up front, whether these future creditors are voluntary creditors who signed a contract with you or involuntary creditors who are injured without a contract signed in advance.
Incorporating Can Protect Your Personal Assets
One way to plan ahead is to incorporate. This creates a shield between your personal assets and the company’s liabilities. Limited liability is a wonderful thing we often take for granted. Even though the musician owns the touring company, the musician hasn’t done anything wrong directly. The musician is protected from liability because he formed his touring company as a Delaware Limited Liability Company, so although the LLC may be a proper party, the musician himself is not personally responsible, and the musician can be removed from the lawsuit. Had the touring company not incorporated, the musician and possibly all of his bandmates would be personally liable for all actions and liabilities of the touring company. If the company is incorporated, a negative judgment would only be against the company and not against the owner-musician personally. The LLC has a shield to protect its owners from this liability.
Nevertheless, even if incorporated, the other revenues of the LLC from the whole tour in every city may be exposed. The revenue from the very profitable concerts which the touring company organized since the LLC was formed could be available to the judgment creditor. That’s a much bigger pool of assets to which the creditor may have access, compared to only the revenue from the show at the Queen Theater.
What if there was a better way to set up the LLC to protect the revenue from the other cities and only expose the revenue from the Queen Theater? What if there was a way to turn one big pocket into many small pockets?
The Series LLC Allows You to Separate Your Assets
There’s a conventional way to separate these assets to prevent many assets from being exposed to any given creditor liability. Many attorneys and business owners know the conventional way. To turn a big pocket into little pockets, the touring company could set up many separate LLCs. Each venue’s revenue would be in its own LLC “box”. This could be dozens of LLCs. For example, the Queen Theater would be in its own particular LLC under the touring company. This way, only the revenues associated with the Queen Theater are available to the judgment creditor because that is where the injury took place and the other venues are separately incorporated. The creditor would not have a right to collect against any of the other assets from the performances in other cities. This approach is proven but it has drawbacks. It requires many filing fees and organization to maintain dozens of short-lived single-purpose LLCs. This can become really cumbersome to set up and maintain. In reality, not many touring companies go out of their way to set up dozens of LLCs for a band’s US tour.
There is an alternative streamlined way to have this type of limited liability without many LLCs. A Series LLC is a particular type of LLC that the Delaware legislature invented in 1996 that lets you take one LLC and break it down into its component parts. Instead of having just one overarching shield to protect owners from the liabilities of the company they own, one Series LLC allows you to establish an unlimited number of protected shields associated with assets of the company. That way if you have a problem with one aspect of the company, then you have pre-isolated and partitioned assets each into their own protective series, fenced off from other assets. Therefore, the entire Series LLC and every other one of its particular protected series aren’t necessarily responsible when something goes wrong with any one ring-fenced protected series of that series LLC. For instance, if a coffee burn occurs at the Queen Theater, the injured plaintiffs should not be able to sue both the Series LLC and all of its other protected series. Only the Queen Theater series should be exposed to the creditor. The series LLC may be a practical way to limit the plaintiffs to suing only one protected series that only holds the revenues from the Queen Theater and other related parties whose actions or inactions gave rise to the transactions or occurrences. This should work because each protected series within the Series LLC is a “legal person” in the eyes of the law. The protected series can sue and be sued separately. The other protected series are unrelated to the injury and could be dismissed, even if named in the lawsuit.
The exciting thing about the Series LLC is that it’s not limited to just Delaware. Delaware was the first state to have the Series LLC, thirteen states have since adopted it. The Uniform Law Commission, which is an organization that gets together and creates proposed laws across the US, just finalized an act with the objective to unify the way these laws are created by other states. This is no longer an obscure type of business entity. More states are adopting the Series LLC. Virginia and Arizona are proposing to be the next two states to adopt the laws.
The Way the Series LLC Works Is Simple
A Series LLC is like safe deposit boxes in a vault. If you go into a vault you might see shelves of locked boxes on the walls. A Series LLC lets you establish an unlimited number of little boxes with keys within this one company. That way, if a creditor has a judgment against one protected series, that creditor just has a judgment against that one particular protected “box”. It’s a way to segregate out and partition other assets from any given liability.
Real estate investors are using the Series LLC to set up, for example, ten properties in ten protected series. The investors may form a Series LLC and establish ten protected series in the name of protected series one, protected series two, etc. The owners can internally establish these protected series without having to go back to the secretary of state and file a new Certificate of Formation. The records of protected series establishment are all internal under the Series LLC operating agreement.
The protected series are legal persons. This is first time in United States history where private citizens have been empowered to establish an unlimited number of persons with only one Certificate of Formation. It is blank check to establish as may legal persons as you would like. How amazing is it that you can decide to wake up one day and establish new protected series as separate persons without even a trip to the filing office to designate series or an additional fee after the initial Certificate of Formation filing?
There are about 100,000 Series LLC’s in use across the country in the 13 states that now allow them. Each Series LLC may have only one or two protected series. Some may have dozens, hundreds, thousands, or even millions of protected series established in any given Series LLC. While this large number may be disconcerting, most are being used safely and not being sued. Very few cases have involved Series LLCs or their protected series. This is a wild world we’re moving into with business entities.
Many Types of Businesses Can Use the Series LLC
This Series LLC can be beneficial to all types of businesses. Serial entrepreneurs who want to incubate different businesses, real estate investors, and even big businesses can use it. The power brokers who initially created the legislation for the Series LLC are the ones who want to keep this for themselves and not for the common man. They are using these Series LLCs for mutual funds, private equity and captive insurance companies.
One example of a company with a high number of protected series within a single Series LLC is a fleet of autonomous vehicles. Every vehicle could be in its own protected series. Or Getty Images—they have millions of copyrights. Every image could go into its own protected series to have them licensed separately by separate owners. This is one way to reduce enterprise-wide risk down into specific risk vectors and separate them legally.
The Series LLC is a way to revolutionize the way we think of entities. Entities don’t have to be static. Entities can constantly evolve. The organization can automatically establish a new protected series to itself as it acquires assets. It may not even be people who establish these new protected series within the Series LLC. It may be the companies themselves automating this process with computer software to establish rules and triggers through artificial intelligence. Those rules could say that as the Series LLC acquires new assets, it will dynamically establish a new protected series, fund the protected series, and keep track of the records in the protected series for each new asset it acquires.
The Future of the Series LLC
We may even use further technology to bulletproof the series protection. You wouldn’t want people accusing your Series LLCs of mischief or playing a shell game. The series LLC could use Blockchain technology that puts asset ledgers on a public or private distributed ledger that no one person can change. This way, anyone can know what assets were owned by any protected series at the time when someone drops the coffee. This allows the business owner to prove definitively what assets were owned by which protected series. It’s a real innovation in mitigating the risks associated with deep pockets. It allows businesses to do things that are beyond the scope of what they’ve ever been able to do before. Every asset is tagged and tracked to easily report on its ownership at any point in time.
Surprisingly only 1% of the new Delaware LLC’s now are taking advantage of the Series LLC provisions available in Delaware. Thirteen other states have the Series LLC law. Most are copying the Delaware version of the law to avoid losing business to Delaware. In addition, just recently the Uniform Protected Series Act was adopted when the Uniform Law Commission approved it in July 2017. This is an invitation in neon lights for the other 37 states to adopt a Series LLC act.
You haven’t heard about the Series LLC yet because they don’t teach it in law schools, business schools, and it doesn’t appear in entrepreneurship books. I invite you to look into the series LLC to determine if it would be a good fit for you or someone you know. The limit on the number of protected series is your imagination and your ability to keep track of the records.
Don’t think big about business. Think small.
