11 Common Mistakes People Make After Forming a Delaware LLC
Forming a Delaware LLC is an exciting time for your company, but it’s important to operate your company the right way afterward. Unfortunately, mistakes are sometimes made. These are some of the biggest issues we see—and how to remedy them.
Mistake No. 1: The Operating Agreement is returned to the formation agent.
Some business owners will send back their company’s Operating Agreement to their formation agent. An Operating Agreement is not kept in state records or in the formation agent’s files. The Operating Agreement is an internal contract between the members governing management and ownership. It should be on file only (1) in the company’s own books and records for safe keeping; and (2) for home reference with each member’s personal financial documents.
Mistake No. 2: The Operating Agreement isn’t signed.
Some business owners think they are done with business formation after their Certificate of Formation is on record with the Secretary of State. When they receive the package from the formation agent, they often do not follow instructions on how to complete and sign the company’s Operating Agreement. They also may not read the Operating Agreement to make sure no modifications are needed before signing it. Many business owners are eager to move on from the mechanical process of business formation and focus on the next steps. A court may accept an unsigned Operating Agreement as evidence of the intent of the LLC’s members. However, putting pen to paper is a better way to prevent a business partner from denying their consent to it.
Mistake No. 3: Franchise taxes aren’t paid.
Having a Delaware LLC requires regular “maintenance fees” be paid to the state of formation. Filing an LLC and keeping an LLC in good standing are not “one and done” transactions. After paying the filing fees to the state of formation and the associated fee to your incorporator (including the state filing fee, first year registered agent fee, and Operating Agreement preparation fee), your LLC will owe the state of Delaware what is called a “franchise tax” each year on June 1, starting in the first calendar year after the year of formation (e.g., formation in 2021 requires franchise tax to be paid on or before June 1, 2022).
The term “franchise tax” can be misleading to first time business owners. It is not based on business income and has nothing to do with chains of businesses controlled by franchisees. LLCs must pay it regardless of business activity to keep the privilege of having an active business entity. Your registered agent will mail you the Delaware franchise tax notice before the due date. To keep a Delaware LLC in good standing (preserving asset protection benefits), the LLC should continue to pay franchise tax each year after formation, until the eventual cancellation of the LLC, at which time the Certificate of Cancellation should be filed.
Mistake No. 4: Registered agent fees aren’t paid.
Similar to the franchise tax issue above, customers may also neglect to pay their registered agent its annual service fee. The agent fulfills the statutory role of receiving and forwarding lawsuits (known as “service of process”) and franchise tax notices on behalf of the LLC. Many registered agents will include the first-year registered agent fee in the formation package. The first annual registered agent fee will be due after that initial period. Neglecting to pay your registered agent could result in agent resignation. This results in the company losing its right to conduct business.
Mistake No. 5: Contact information isn’t up to date.
A ”communications contact” is defined by Delaware code as the person who is authorized to receive communications from the registered agent. Registered agents keep the name, address and phone number of the communications contact in their records. They direct Delaware Secretary of State mailings and lawsuits to the address provided. Occasionally, owners will delegate the responsibility of the communications contact to an officer or administrative assistant. When that person leaves the company, LLC members sometimes forget to notify their registered agent to update the contact information. This risks lawsuits being directed to the wrong person and could result in a default judgment, if lawsuits go unanswered.
Mistake No. 6: Doing business under a different name without creating a DBA.
Any time an LLC enters into a contract with a vendor or one of its customers, the member or manager should resist signing their name without being clear it is only as an agent on behalf of the LLC. All signature blocks on business contracts should start with the LLC’s name and the signature line underneath should be signed ”By:” the managing member, manager, officer or other designee as “Authorized Person”. The signature should not list “Member” because an owner does not imply agency. Also, it could be construed as the owner signing personally.
Similarly, if an LLC chooses to do business under a different name, either online, in person or both, the LLC should consider filing a d/b/a (trade name or “Doing Business As”) with the New Castle County prothonotary’s office to make banking easier. The d/b/a should never be used in place of the LLC’s official name in contracts.
Mistake No. 7: Creating membership/ownership certificates for your LLC.
Stock certificates are for corporations. An LLC, on the other hand, should document ownership in its Operating Agreement. After signing, distribute copies of the Operating Agreement to each member. A corporation has Bylaws, Minutes of the Meeting of Incorporator, Unanimous Action of Initial Directors, a stock ledger, stock certificates and often times a shareholder agreement. By comparison, a Delaware LLC’s Operating Agreement specifies ownership and management in the form of a contract. Creating membership/ownership certificates for an LLC usually does not have legal significance. It may even conflict with what is written in the governing contract, the Operating Agreement.
Mistake No. 8: Failing to file a Certificate of Authority to do business in another state.
An LLC is a “domestic” entity in its state of formation. ln each state where it does business with employees or an office and the state where its headquarters is located, the LLC should register, known as “qualifying,” as a foreign LLC doing business in each “foreign” state through a Certificate of Authority. Incorporating in multiple states is not the correct way to “qualify” a foreign LLC to do business. Instead, it just creates multiple entities which is not the result intended by most business owners.
Mistake No. 9: Leaving blanks in the Operating Agreement.
When you form your LLC, most formation agents will send you an Operating Agreement for the company with a few blanks. The blanks must be filled-out before the members sign on the last page. ln a long Operating Agreement, the blanks can easily be missed. You should fill out the principal place of business, capital contributions, member addresses for notice purposes, allocation of ownership/membership units, tax matters member and all other blanks.
Mistake No. 10: Listing the registered agent’s address as your office address and/or mailing address.
Mistake No. 11: Failing to file your FinCEN beneficial owner filing.
This FinCEN beneficial owner filing is a new federal requirement that was part of the 2020 Defense Act. Every business entity unit must comply or risk enormous fines and jail time for its owners and managers. The details of this filing will be part of forthcoming regulations yet to be promulgated by the United States Department of the Treasury. These filings are required at the time of formation and annually every year thereafter. If there is a change in management or ownership of the business entity, a filing is also required. The listed owners must be “beneficial owners” who are human beings, up the line regardless of a large organizational structure with intermediary entities. Some exceptions exist, for example 501(c)(3) organizations will be exempt. Almost all small businesses will be required to make these filings.