Thinking About Starting a New Business?
If you are operating your business as a sole proprietorship (with or without a fictitious business name) you should seriously consider operating as a corporation or limited liability company (LLC). This also goes for anyone who wants to start a business. (It’s often easier to incorporate at the beginning as opposed to transferring a sole proprietorship to a corporate entity later.) Nevertheless, both entities allow you to limit exposure from lawsuits.
Both corporations and LLCs enjoy a corporate veil which protects the shareholders or members from lawsuits filed against the entity. So for instance, if you or your employee’s injure someone in the course of business, then under normal circumstances, the corporate veil will protect you the shareholder from liability.
LLCs allow tremendous flexibility for estate planning purposes. Naturally, estate planning is done to make sure your heirs are aided by your industry as opposed to creditors or the IRS. LLCs provide substantial protection of your assets from creditors. For instance, you may provide a membership interest to your heirs while still maintaining your control over the business even if your heir gets into legal difficulties with creditors.
The important thing is retention of an attorney who can draft you an airtight operating agreement. An LLC is run by its Operating Agreement. There are numerous ways the Operating Agreement can provide protection to you from your heirs’ bad credit decisions (or your heirs from your bad credit decisions).
For instance, the agreement may limit the admission of new members and can keep the manager(s) from admitting new members. It can also keep members from voluntarily transferring or encumbering all or any portion of their interests in the company. This with a right of first refusal will keep your “heir” from selling his membership interest to anyone but you. It also restricts the member’s right to receive profits, losses and distributions of money from the company. This and the right of first refusal gives you controlling interest in the company.
Other situations may arise where a member doesn’t so much want to sell, but that through certain events he must sell. For example, you will greatly appreciate being able to buy the member’s interest or not give them controlling interest in the event of death, bankruptcy, insanity or incompetence, conviction of a felony, involvement in an activity that harms the business or reputation of the company, failure to make a capital contribution, termination of employment if employed by the company, divorce where the inactive spouse obtains the interest of the active spouse in a property settlement, and a member’s default of any obligation owed by the member to the company.
The agreement may be tweaked to provide for allocation and distribution. It can specify when and how much distributions thereby depriving a new member from demanding an allocation or distribution. Another way to limit the new member’s interest in pursuing the interest is the capital contribution requirement. Typically a member is not obligated to contribute money or property or make a capital contribution to LLC unless the member agrees to do so in a written document signed by the member. This is tremendously important for estate planning purposes. Can you imagine a creditor getting a court ordered liquidation of a debtor member’s membership interest and trying to sell the interest when it requires the member pay $5,000, $10,000 or more in capital contributions? The membership interest will be virtually worthless to a creditor.