September 15, 2023
<span id="article">The</span> limited liability company – a creature of statute that only came into existence in most U.S. states and the District of Columbia within the past thirty years or so – is by a wide margin the most popular choice of business entity for owners of closely held businesses<sup><a href="#footnote">1</a></sup> in America today. LLCs were created as a hybrid between a corporation and a partnership, offering some of the best attributes, while bypassing some of the drawbacks, of each of those entity types.
One corporation-like advantage that LLCs offer over limited and general partnerships is the right to have the business be owned by a single Member (whether a natural person or an entity), without the need to have even a fractional percentage of company interest be held by another party. While Single Member LLCs (unlike, for example, single shareholder corporations) are considered “disregarded entities” by the IRS – in other words, all taxable income and loss is passed through to, and reported on the tax return of, the Sole Member using the Sole Member’s Federal Tax I.D. Number – they offer the important advantage of liability limitation for the Sole Member, <span style = "text-decoration: underline;">provided</span> that the Sole Member takes certain precautions to organize and operate the company in the right way.
Here are some key “Dos” and “Don’ts” for the owner of a Single Member LLC:
<ul><li><span style = "text-decoration: underline;">DO take measures to create a clear separation of the business from the individual.</span> The Sole Member should, among other things, establish a separate bank account(s) in the name of the LLC, to prevent the intermingling of the finances of the company with those of the Sole Owner, and should conduct all business and affairs of the company, including entering into any contract, lease, loan transaction, employment agreement, or other business arrangement, solely in the name of the LLC. The objective is to take reasonable precautions to avoid a future scenario in which someone who asserts any legal claim or suit against the company will not prevail in asserting that the owner should also be personally liable (or, vice versa, that any claimant against the owner will not prevail in asserting that the LLC should also be liable), under the common law doctrine that the company and its owner are “alter egos” of one another.</li></ul><ul><li><span style = "text-decoration: underline;">DO make sure that any website(s), social media account(s), email domain(s), and any other advertising or outreach relating to the business, is established in the name of the LLC (or in any trade name of the LLC) only.</span> This is a corollary to the above point. Having the public-facing aspects of the business – not only the examples mentioned above, but also “low-tech” items such as business cards, letterhead stationery, preprinted business forms, print advertising, and any signage for a bricks-and-mortar location – consistently reflect the LLC’s name (or any registered trade name owned by the LLC) is another important way to reinforce the point that the owner of the company and the company itself are two separate “persons” and are not alter egos of one another.</li></ul>
<ul><li><p><span style = "text-decoration: underline;">DO have a well-prepared operating agreement for the LLC.</span> Even if an operating agreement for the LLC is not required by law – under Maryland’s LLC Act, for example, it is not – it is always advisable to have one, even when the company is a Single Member LLC and you as the Sole Member are essentially “agreeing with yourself”. First of all, having an operating agreement helps to further reinforce the separation of the owner from the company, which is essential to secure the liability protection of the LLC entity type as discussed in the two points above.</p><p>Further, many of the company’s transactional partners – banks, most commonly, for purposes of opening any account or obtaining a loan, but also other parties such as landlords, prospective investors, and others – often require, or at least request, a copy of the operating agreement as a threshold requirement of the transaction, regardless of whether the company has multiple members or just a single member. In such a scenario, having a written and signed operating agreement helps reinforce the impression that the business is “legit” and also reassures the transactional partner that the person they are dealing with, whether the Sole Owner or any non-member manager of the LLC that may be named in the operating agreement, does in fact have the authority to negotiate deal terms and sign documents in the name of, and legally binding upon, the company. (And yes, to remove all doubt, the Sole Member is not obligated to be the manager of the LLC, but rather, can appoint another person or entity to be the manager, including appointing them to serve as a co-manager with, or as the successor manager to, the Sole Owner, as further discussed below). </p></li></ul><ul><li style="list-style-type: none;">One final reason to make sure to have an operating agreement, even for a Single Member LLC, is that, without one, the default or baseline terms established by the applicable LLC statute will govern the operations of the LLC, including such important matters as the company’s powers and authorities to take certain actions, its relations with third parties (including any creditors of the LLC), and the procedures that will apply in any dissolution of the company, or if anything should happen to a member (or, in the case of a Single Member LLC, the member). Those baseline statutory terms are developed to apply to the broadest array of LLC-related circumstances (i.e., using a “lowest common denominator” approach), and it is not by accident that those statutes are frequently modified by phrases such as “unless agreed otherwise”, or “unless the operating agreement states otherwise” – because in many of those subject areas, the LLC’s members do in fact elect to have the operating agreement establish powers, governance procedures, and operational outcomes that the members consider preferable to the baseline terms of the statute.</li></ul>
<ul><li><p><span style = "text-decoration: underline;">DON’T forget to plan for the future.</span> A Single Member LLC is usually formed at a time when the Sole Member is the primary driving force behind the business (and, in a small company or venture, is perhaps the only active participant, i.e., the “chief cook and bottle washer”, in the business). There is nothing surprising about that. However, if the business of the LLC is one that thrives and prospers, perhaps acquiring a solid customer base for its goods and services, and possibly acquiring employees to carry on its business operations– or if the nature of the LLC’s business is to be a holding company for a durable asset, such as real property or interests in another business entity – then there is a foreseeable likelihood that a day could come when the Sole Member could die or become incapacitated while the business of the LLC is still ongoing. </p><p>It is important for the Sole Member to have a plan in place for that eventuality, to ensure that a thriving business does not collapse by the loss of the Sole Member’s day-to-day presence and efforts, and/or that ownership of the company does not pass to one or more heirs of the Sole Owner who may be incapable of managing (for example a minor child or children),or who may be otherwise unavailable for or uninterested in managing, the company’s business and affairs.</p></li></ul><ul><li style="list-style-type: none;"><p>The Sole Owner should consider drafting, or amending, as the case may be, the operating agreement provisions to memorialize (in concert with any provisions that may be contained in any estate planning documents, such as a will or trust) a succession plan. Perhaps there is a key, trusted employee who understands the business, that the Sole Member would like to designate – after confirming with such person first, of course – to become the successor (non-member) manager of the LLC upon the death or incapacity of the Sole Member, who can be fairly and reasonably compensated for such managerial services, while the net cash flow of the business (after the payment of such manager’s compensation and the compensation of all other employees, and all other operating expenses of the company) gets distributed to or for benefit of the Sole Member if still living, or to the Sole Members heir(s) if deceased. Or perhaps, if the Sole Member has more than one family member, for example, a spouse or one or more adult children, who would be an heir to the ownership interest in the LLC if the Sole Member were to die, and if some of those family members are involved in, or interested in (and capable of) being involved in, the business of the company while others are not, then the Sole Member can establish a succession plan that would eliminate any guesswork or squabbling as to how the business would continue to be operated and managed among all of the family members following the Sole Member’s death or incapacitation.</p><p>Whatever the specific facts, issues, and circumstances are, the point here is that the Sole Member should not overlook the importance of planning for a future scenario in which the Sole Member is no longer alive or able to be involved with the company and its business, and further, should not fail to understand that the operating agreement can be one of the most essential documents for memorializing that plan and causing it to be carried out, whenever that day should come.</p></li></ul>
<ul><li><span style = "text-decoration: underline;">DON’T forget that an operating agreement is a 100% internal company document.</span> Every LLC’s operating agreement is an internal company document that can be drafted, amended, and, as the case may be, completely restated by the company’s members, from time to time and at any time, to contain whatever provisions the members agree upon (provided those provisions are not contrary to law). It does not need to be filed or recorded with a government office (unlike the LLC’s Articles of Organization and any amendments to same, which must be filed with the corporate entity registration office of the applicable jurisdiction). In the case of an operating agreement of a Single Member LLC, the latitude is even greater, as the Sole Member does not need to confer with or obtain the approval of any other member or other person. </li></ul>
If you are, or if you plan to be, the Sole Member of a Single Member LLC, and if you have any questions about preparing or amending the operating agreement of your company – whether to ensure the full liability protection of the LLC entity type and/or to incorporate succession planning provisions, as discussed above, or for any other reason – or otherwise about choosing the correct business entity type and getting it formed and organized, the attorneys at RKW are here to help you!
<span id="footnote"> <span>
<sup>1.</sup> At least for those businesses that are afforded the option to be formed and operated as LLCs under applicable law. Some jurisdictions require that certain types of businesses be registered and conducted only through specified types of business entities that do not include LLCs. <a href="#article">Return to article</a>