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Limited Liability Companies (LLCs): Avoiding Disasters, Mistakes and Confusion!

I see it several times per day, everyday: An LLC disaster waiting to happen! No matter where I travel or with whom I speak, it’s clear that small to mid-sized business owners are not getting proper instruction on how to create, run, and maintain a ‘rock solid’ LLC. Did you or your attorney form your LLC? Are you now left with a stack of papers and confusion?

One comment that I repeatedly hear is, “Well, my attorney set it up for me two years ago…so everything is rock solid.” Usually, without much probing, I soon learn that little else has been done since then. I will typically find that even the attorney may have missed a few steps along the way! In fact, we have uncovered 24 mistakes/traps that LLC owners face all the time! Many of these mistakes are even made by attorneys, experienced business owners, and very talented people. So if you want to avoid disasters and create a ‘rock solid’ LLC…let’s get started!

While I can’t cover all 24 mistakes and traps in this article, let’s talk about the first 5 mistakes in some detail:

1) The ‘Fatal Death’ Personal Liability Clause
A handful of states have a strange option in their articles of organization forms which can be d-i-s-a-s-t-r-o-u-s. Some states require the filer to select whether or not LLC members will be personally liable for the business debts of the LLC. Obviously, members should not be personally liable for LLC debts and obligations! This is the reason you are forming an LLC to begin with…remember? Carefully read the articles of organization or similar formation documents in all states. Make sure that you and your attorney do not accept member personal liability for business debts. If you had an attorney or filing service submit your organizing documents for you, then it is always a good idea to ‘double check’ this area. Make modifications if needed. You would be surprised how many times it’s a secretary, legal assistant or clerk who actually completes your precious articles of organization. Just because a box exists, this does not mean you should ‘checkmark’ it!

2) Not Maintaining “Required” Records
Here is an area where much confusion exists. When I talk about required records, I almost always get the same response, “I don’t want to keep records…that’s why I chose the LLC over a corporation!”

Hold on one minute…because you may be surprised to learn that almost every state requires the LLC to maintain certain key records. In fact, maintaining ‘key records’ is one of the few ‘formalities’ that states do impose on the LLC. As a result, this can be a prime target area of attack if a suing attorney, the IRS, or a bankruptcy court wishes to ‘set aside’ or ‘penetrate’ the LLC.

We have reviewed this area in much detail for all 50 states and D.C., and I can tell you that each is different. Regardless of what your attorney, accountant, best friend, or local guru tells you, this is a must do area! Some common records include: copies of resolutions, unanimous consent forms, copies of meeting minutes, tax returns (from 3 to 6 years), the names and addresses of all current and former members and/or managers, a copy of the operating agreement and more!

3) Failing To Understand and Review Your Operating Agreement
This is an all too common mistake. The operating agreement is perhaps the most important document of the LLC! The operating agreement is an ‘internal’ set of rules for the company. It is basically a contract among members of the LLC. Even if you are the only LLC member this document is very important! We continually find that many business owners have a generic operating agreement that has never been reviewed or even signed by members!

Even worse, most operating agreements are usually missing some KEY components. In fact, we have isolated 43 to 45 key components that must be included in almost all operating agreements. Most canned and even ‘customized’ agreements only contain about 25 to 30 of these components. At a bare minimum, you should understand what the ‘best practices’ are regarding operating agreements and then compare this ‘gold standard’ to what you have. Special tax treatments for the LLC (such as the popular S-corporation tax treatment under Sub Chapter S) will require additional terms and controls!

4) Failing To Complete the “Big 10” After Forming The LLC:
It does not matter whether you file the LLC paperwork yourself, hire an attorney or other service these things must be completed. This is one mistake we see over and over again! Most business owners routinely forget to complete the ‘Big 10’ important steps within 30 days of forming the LLC. Here are 7 of the steps:

1) Conduct the First Organizational Meeting of the LLC – This is really important and will allow you to create solid safeguards and ‘often forgotten’ controls. There are about 11 things that should occur at this meeting!
2) Obtain Employer’s Identification Number (‘EIN’) from the IRS
3) Register Your Business Name with the County Name Registrar
4) Register with your State Department of Revenue and Comply with State Sales Tax Rules
5) Collect Member Capital Contributions and Transfer Cash or Hard Assets into the LLC (With proper instruction this is simple…if done incorrectly a liability disaster can occur!)
6) Obtain the Proper Business Licenses
7) Review Insurance Coverage Needs and Limitations

5) Failure To Properly Evaluate And Choose Your Team Of Professionals:
This is perhaps one of the toughest things for the real estate investor and small business owner to do. Part of the problem is that most of these professionals (e.g., attorneys and accountants) will know more than the average business owner regarding legal and tax issues. Sometimes the big mahogany desk and the plush office will make them seem even smarter! Take it from me, ‘ivory tower’ law and accounting programs really don’t teach you how to run an LLC for maximum tax savings and asset protection. It seems to be a lost art these days! The truth is that the competency of legal and tax services can range from great to very poor! You need to be able to evaluate this for yourself!

The challenge is that most people who contact an attorney or accountant rarely have a true two-sided discussion! After all, it’s nearly impossible to ask the right questions and comprehend all your of options unless you fully understand the choices and variations available. The Answer: Educate Yourself First! One thing that I have learned over the years is this: no one will care as much about your business as you. It may be sad but accept this today…in fact, right now! Take advantage of top quality home study systems and detailed instruction. Learn about your options and the ‘best practices’ for real estate investors and business owners. Seek out those who want to help and educate! Then when evaluating an attorney or accountant you can ask them the ‘tough’ questions and see if they can answer or if they squirm! Doesn’t this sound like a better position to be in? You will be better able to choose your team and you can ensure that the person who cares the most about your business can make informed decisions about the business!

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