How To Structure a Series LLC
The Series LLC has garnered much attention since it was first introduced in Delaware in 1996, and with good reason. A Series LLC allows owners to save on filing fees by being able to set up as many ‘daughter’ protected series as the members see fit. Here’s what you need to know about structuring your own series LLC.
What Is a Series LLC?
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. As a result, one protected series within the Series LLC may be insulated from the debts and liabilities of all other protected series of the LLC.
Series LLC Benefits
A Series LLC provides for internal asset segregation through its ability to create an unlimited number of horizontal internal “firewalls” called protected series. A traditional LLC or corporation does not have that ability. To accomplish that with a traditional LLC or corporation, a business owner would need to form a separate entity and pay the associated fees.
Designating a protected series can be done without public filings and additional state fees. This is why a Series LLC might be more cost-efficient than forming several LLCs for subsidiary businesses or for the purpose of holding title to passive assets like real estate.
A protected series of a Series LLC is allowed to break off from the parent LLC into a traditional LLC or another Series LLC as a separate unassociated business. It may also break off for the purpose of seeking bankruptcy protection separately because each protected series is a separate “person” under the law.
How to Create a Series LLC
One initial decision in building the structure of the Series LLC is deciding who are to be the members associated with each protected series. Usually each protected series has the same individual members associated with it. This uniformity of ownership of each protected series causes the profits and losses of each protected series to flow to members directly and not through the mothership LLC.
To use a simple example, ABC Capital LLC can be a single-member Delaware Series LLC with Abel Adams as a member. It usually has Abel Adams as the single member of ABC Capital LLC, protected series 1; with Abel Adams also as the member associated with protected series 2; and Abel Adams associated with protected series 3.
In the partnership setting, XYZ Capital LLC would be a multi-member Delaware Series LLC with Abel Adams and Bob Best as members. It would then have Abel Adams and Bob Best as the two members of XYZ Capital LLC, Protected Series 1; with Abel Adams and Bob Best also as the members associated with XYZ Capital LLC, Protected Series 2; and Abel Adams and Bob Best associated with XYZ Capital LLC, Protected Series 3.
These examples are not “parent-child” relationships because the relationship between protected series is horizontal (brother-sister), and not a vertical parent-subsidiary relationship.
Series LLC Structure Advantages
Uniformity of ownership has its advantages with avoiding internal jealousy and conflict between members. We do not suggest having different members associated with each protected series because it is unwieldy and runs a high potential for conflict when ownership is not aligned between protected series. Therefore, do not associate Carrie Crawford with an individual protected series unless she is also associated with all protected series therein. Ideally, the ownership is mirrored in each protected series, so each member or members associated with any protected series is associated with every protected series in the same ownership percentage. This minimizes the risks of in-fighting between members. Chances are any future attacks on your company are much more likely to come from the insider members than from outsiders who are not members.
While some suggest having different ownership and control to avoid “associate liability” or “enterprise liability”, difference in control will create a conflict-ridden complex structure, which often leads to in-fighting.
Example Structures of a Series LLC
The most common and recommended structure of a Series LLC is one which has a “master” Series LLC which names certain members in its master LLC Agreement. This is the LLC name that is on record with the State of Formation and the name listed on the Certificate of Formation. That master Series LLC establishes individual protected series which hold separate assets, keep separate books and have their own members, although the individual protected series will often have the same members as the master Series LLC. Typically, Protected Series 1 will be the management protected series, responsible for managing the operations of the business. Protected Series 2 and on will hold separate pieces of property or operate different segments of the business.
A less-common Series LLC structure is diagrammed above. This configuration establishes separate protected series and assigns certain assets to each, as in the first example, but here, the master Series LLC is the member of each protected series rather than each member individually.
Regardless of whether a Series LLC is structured like the first or second configuration, it is important to keep accurate and detailed books and records. Leaving assets unassociated with an individual protected series or the Company makes the asset potential fair game for judgement creditors of the Company or other protected series. Also, it may raise the issue of inaccurate books and records and give creditors a theory to attack other individual protected series.
Who Forms a Series LLC?
Series LLCs started as special interest legislation of the mutual fund industry. Fund managers wanted to have protections and benefits of multiple LLCs contained in a single entity without the added cost and administrative effort. These companies were also concerned about liability separateness and the right of each fund to be managed independently. Their solution was to create an LLC that would be like a potential cell company which could have daughter funds all within one SEC filing. They included provisions allow each class of funds to sue and be sued in their own name and to contract in the name of each fund.
Today, the common uses of the Series LLC have evolved to entrepreneurs designating protected series to incubate business startups, and investors holding passive, low-risk assets like commercial real estate. The Series LLC addresses many of the concerns of these serial entrepreneurs and real estate investors because it allows them to keep their liabilities separate while reducing the number of filings they need to make with the Secretary of State.
How to Pay Taxes on a Series LLC
When states began to enact Series LLC statutes, it had already been settled that the traditional LLC could elect to be taxed in a variety of ways. This is known as ‘check the box’ regulations. However, it was uncertain how the protected series of a Series LLC would be treated by the IRS. Would they qualify as distinct legal entities who could elect their treatment for tax purposes? Would they have to assume the tax classification of the company generally and be taxed as an individual entity? Or would the whole series LLC, including the cells and the company, be taxed as a single entity?
The IRS issued a private letter ruling, stating that different cells are allowed to choose their own tax treatment, based on their individual businesses and membership structures (disregarded entity, partnership, C-Corp, or S-Corp). This means that a cell can elect how it is to be treated for Federal Income Tax like a business entity that is distinct from the other cells of the same LLC.
In 2010, the IRS issued a proposed revenue rule to provide taxpayers guidance on the Series LLC (2010-22793). The IRS said it deemed protected series to be separate taxable entities. This gave the Series LLC more certainty about how to file returns. However, the rule may require filing an additional partnership tax return (1065) for each additional series. To date, the IRS has not finalized the proposed revenue ruling.
How to Form a Series LLC
As with a traditional Delaware LLC, to form a Series LLC, you must (1) pay the $90 payment to the Delaware Division of Corporations and (2) file the standard one-page Certificate of Formation naming the registered agent. In addition, the Certificate of Formation for a Series LLC must contain an extra paragraph in the Certificate of Formation to put the public on notice that the LLC has the right to create protected series. Upon filing the Certificate of Formation, it is very important to sign a detailed Operating Agreement especially drafted to be used for the Series LLC.
Additional resources on the Delaware Series LLC
- What is a Delaware Series LLC?
- The Delaware Series LLC vs. Other States
- Delaware Series LLC Operating Agreement