Limited Liability Companies: Formation and Member Benefits

Selecting an appropriate business entity is among the first of many important decisions that an entrepreneur must make. Although each new venture is different, a limited liability company (“LLC”) provides significant flexibility for the owners and operators of the organization and also limits the liability of individuals involved in the business.

A. FORMATION OF THE LLC

An LLC is formed by filing articles of organization with the Secretary of State. In order to accomplish this, the LLC must have at least one member. The articles of organization must contain the following information:

  1. Name - the LLC must have a unique name and must contain the words "limited liability company," "limited company" or the "LLC" abbreviation. Name availability can be checked by searching the filings maintained by the Office of the Secretary of State website, or by calling (502) 564-3490.

  2. Registered Office - the LLC must list a registered office address for the business entity. This address must be a valid street address in Kentucky. A PO Box number is insufficient.

  3. Registered Agent - the LLC must name a registered agent. The individual or business named as the registered agent consents to receive service of process in the event that the business is named as a party in a legal action.

In addition to the information listed above, an organizer must also pay a filing fee to the Office of the Secretary of State. Once the entity is formed, the business must file an annual report with the Secretary of State between January 1 and June 30 of the year following the calendar year in which the company was formed. A statement of change must also be filed in the event of any changes to the registered agent or registered office occur.

 B. LIMITED LIABILITY

Once an LLC is formed, the business becomes a legal entity separate and distinct from its members. The LLC may own property, enter into contractual agreements, take on debt, and otherwise do all things necessary or convenient to carry out its business or affairs. Members of the LLC are indemnified for such debts, obligations, and other liabilities incurred in the course of their activities while acting on behalf of the LLC. Essentially, members and managers of the business are not personally liable for the LLC’s obligations. This means that personal assets individually owned by the member or manager are safe from the LLC’s creditors.

It is important to understand that the limited liability afforded by the LLC entity is not absolute. Generally speaking, professionals are still held personally liable for their own malpractice, and employees may be held personally liable if they incur liability outside of the scope of their employment. Additionally, a court may pierce the corporate veil of the LLC and disregard the limited liability if, for example, members undercapitalized the venture in light of a substantial risk due to the nature of the business.

C. MANAGEMENT OF THE BUSINESS

Management of the LLC is presumed to be the responsibility of its members. However, members may execute an operating agreement to outline the desired management structure of the business. Unless otherwise provided for by the operating agreement, a majority vote is generally required to approve most decisions. The ability to tailor an operating agreement specifically to the needs of the individual members gives the LLC a great deal of flexibility. This is often a very desirable feature for entrepreneurs.

LLCs may be member-managed or manager-managed. In a member-managed LLC, the individual members of the business have the authority to act for the benefit of the business. Members owe a duty of loyalty and duty of care when carrying out business on behalf of the LLC.

In contrast, in a manager-managed LLC, management and operation of business dealings are carried out by persons other than the members. This structure may be desired if members wish to remain passive investors in the business, or if certain members are not particularly skilled in management. But, a member may still be involved in the management if so provided for by the operating agreement.

D. TAX ADVANTAGES

LLCs have become the preferred business formation for many entrepreneurs because of their flexibility regarding taxes. If the LLC only has one member, it is taxed the same way as a sole proprietorship. If there are multiple members the LLC can elect to be taxed like a partnership or a corporation. Partnerships and sole proprietorships, and LLCs that are taxed the same way, are known as "pass through entities," meaning the entity itself does not pay tax. Corporations are taxed twice, once at the entity level and once at the shareholder level when profits are passed to the shareholders in the form of dividends. LLCs primary advantage is its ability to offer limited liability to its members, like a corporation, while also enjoying favorable tax treatment, like a partnership.

The attorneys at Barsotti & Manley are prepared to advise you through the formation of your new business and are willing to answer additional questions and discuss the legal implications of your decisions in more detail. Contact our office today at (859) 429-3444.