The 5 Biggest Mistakes Made by New LLCs

Mistake #1 Doing Business Before the LLC is Formed.

You are personally liable for any business activities or transactions that take place before your LLC is formed. A person can sue you years later for something you did today. If your business becomes successful, those early acts could cause you to be the subject of a personal lawsuit. Don't think it has not been done. With over 70,000 lawsuits filed a day, this world is filled with people and their predatory litigation attorneys looking for successful small businesses to attack.

Mistake #2 Failing to Actually Issue Ownership Interests in the LLC.

Many business owners create an LLC but never actually issue ownership interests (known as Membership Units) to the persons that are going to be owners of the LLC (known as Members). It can be easy for you mistakenly think that because you created the LLC, you are automatically the owner of the LLC. The fundamental premise of an LLC is that it is its own separate entity. When an LLC is formed by a state agency, it does not have owners. Membership Units or a percentage interest in the LLC must be issued to the persons who will be the owners. This issuance transaction should be in writing. The LLC Operating Agreement is the typical place where the LLC issues shares to Members. Make sure that after your LLC is formed, you complete this next step.

Mistake #3 Failing to Create a Management Structure.

An LLC needs to have a management structure. A management structure determines who has the authority to make decisions on behalf of the LLC. There are two management structures. A member-managed LLC is when the members automatically have the rights to operate and manage the LLC business. The second is a manager-managed LLC which creates a corporate type structure. A Board of Managers is created and persons who are appointed to that Board have the authority to run the business. The best place to create a management structure is in the LLC's Operating Agreement. All LLC's should have an Operating Agreement as this agreement creates the set of rules for your LLC.

Mistake #4 Failure to Get Investment Obligations in Writing.

The LLC Acts of most states require that all agreements by a Member of an LLC to contribute money to the LLC must be in writing. An oral agreement is not enforceable under the law. If you are planning on starting a new business with other persons, you will likely get together and decide on how much of the business each of you will own and on what obligations each of you are agreeing to with respect to that business. Obligations usually include how much money you are each going to contribute to the business or what kind of services and time commitment each of you will devote to the business.

These conversations take place but in many multi-member LLCs, they are never placed in writing. Without a writing, any oral promises are not enforceable. If you issue Membership Units based on an oral promise and the Member fails to deliver, you cannot take back the Units.

Mistake #5 Thinking that an LLC is a Foolproof Layer of Liability Protection

Yes, it is established that a Member of a properly formed and maintained LLC is not liable for the debts, obligations and lawsuits of the LLC merely by being a Member of the LLC. But, in a realistic business context, persons who are Members are usually not passive owners of the LLC. They are also active managers and operators of the LLC business.

In today's litigious world, all businesses should be run through a limited liability entity such as an LLC. The LLC liability protection is a significant protection vehicle. However, the LLC layer of protection does not extend to all potential liabilities that can arise in the midst of running an LLC. Do your homework in performing the administrative and other tasks of your LLC and retain the proper professionals to advise you when appropriate. There are certain standards and formalities you need to meet or else you run the risk of being personally liable (this risk is known as piercing the veil risk).

The LLC laws do not cover personal negligence. Your LLC should always have insurance to cover these types of business related accidents. Do not ever think that the LLC is enough to protect you in these circumstances. Similarly, there are some laws that hold you liable regardless of whether you are operating through an LLC. The most obvious one that might apply is if you are a licensed professional. Doctors, lawyers, accountants, real estate brokers and dentists, for example, are always personally liable for acts of malpractice. If you are a licensed professional, make sure you get the proper insurance. Also, there are certain tax, environmental and securities laws that you can be held personally liable for if your LLC is in violation of those laws and you were the responsible manager.

Finally, you cannot use your LLC to engage in fraud or hide behind the LLC to protect yourself when you engage in fraudulent or unlawful acts. If you break the law or try to defraud others, the law will hold you personally accountable.

In summary, the LLC is a wonderful vehicle for providing Members with limited liability protection. But, in order to preserve that protection, you cannot just form an LLC and then forget it exists. Make sure you do the necessary things to honor your LLC as a separate entity and also know that the LLC should not be your sole means of protection- get insurance when it makes sense and always invest in the required knowledge for operating your business which includes getting the right help when needed in your business!

Copyright (c) 2007 Amyli McDaniel