Legal Traps to avoid with LLC's

We recently sat down with Dixie Watkins of Davis Business Law to discuss legal issues she sees with LLC’s.  Here is an excerpt from our conversation.

Christian: Somebody gets an LLC formed and they come to you. What are the things that are usually lacking besides, okay, I got the certificate from the Secretary of State.

Dixie: Yeah. Operating agreements are usually trash by the time I see them. If they're not done by an attorney, a lot of people will go to one of those online legal things and get an operating agreement put together with that. I would usually say for most people, you'd want to form an LLC and get a good operating agreement, especially if you have any partners. If it's a multi member LLC, you have to have a good one or you're going to end up paying an attorney later to fight over the things that you forgot to put in your operating agreement.

So I'd say that's the first step. Also if you're going to get a bank account or any of the things that a business needs, you need an operating agreement. Yes, your rocket legal operating agreement would work for that, but it just really doesn't cover all of the things that you need it to be one operating agreement.

Christian: What would be normal things that you see in these boilerplate legal zoom type operating agreements that are wrong or missing or not addressed?

Dixie: The main one that I have the most problems with are not discussing what happens if the business is going to split up. Along with that, if one of the partners passes away or can't operate the business or something like that. Especially in these small businesses, that's really important, especially if the business is going to continue on. You want to address that either in your operating agreement or in a subsequent document.

Typically in these online operating agreements, there's either nothing that talks about transferring ownership interest or selling them or it's just the standard sell for whatever the partners agree the price should be something like that. That's where I see a lot of disputes and you start getting into spending a lot of money on attorneys fees. It's fighting over what the value is or paying someone to evaluate it. And that gets expensive too.

So you can address all of that if you have an LLC, especially because they're so flexible, you can figure out now what you would want to happen if you wanted to sell part of your interest or if your partner wanted to sell part of their interest. You can address that at the beginning. You don't have to wait until there's a breakdown in the partnership. You can figure that all out while everyone's still getting along. That saves a lot of wondering and a lot of disputes in the long run.

Christian: What about husbands and wives? Do you need an operating agreement for that?

Dixie: Yeah, for sure. That's one that you definitely want to have because if you get into a family law court when you have a divorce or something, then those rules are different than just general contract rules. Again, what I was talking about earlier, when you have the members are all getting along, the partners are all getting along, you can go ahead and say how you want things to go. If there's a situation where there's going to be a split, you can do the same thing with a married couple. I know no one likes to think about that, but yeah, it's kind of.

Christian: Like a pre nuptial for the business.

Dixie: Yeah, that's a great way to think about it. Yeah, it's just planning ahead. If something happens, what do we want to happen to the business?

Christian: What else do you normally run into with newly formed LLCs not having?

Good contract in place, especially with the service providers. I've had a lot of those where they just have a meeting with the client and then that's pretty much it. They agree upon or maybe they'll exchange some emails and things, but there's no written contract that says what the service provider’s obligations are and what the customer's obligations are. That leads to a lot of disputes. Again, once you get into disputes, you're having to hire an attorney anyway and pay a lot of money to fight about it rather than getting a good contract at the beginning and using that.

It's definitely economical to go ahead and get the contracts, a template at least drafted and have those in place.

Christian: Talk to me about the importance of keeping the business and personal separate. I know in the corporation they call it piercing the corporate veil. I don't know if that standard applies to an LLC.

Dixie: Let's say you get into a lawsuit or litigation or some kind of dispute. If you set up your corporation or your corporate structure correctly, any suits or claims against your company are separate from your personal assets. So that's kind of the point. You set up these companies, you do that so that you're limiting your liability.

As the name implies, you're giving your personal assets or your other company assets separate from each other. If you've got a photography business and you do whatever, wedding photography, and then maybe you also are a teacher, you keep those funds separate and you keep all of your records separate so that if so and so sue you because they don't like their wedding pictures. Just your wedding photography assets are on the line.

Whatever money is in that account and whatever your assets are, that's what's on the line for that lawsuit. Whereas if you kind of transfer your money back and forth, you use one bank account for everything, your groceries and your props or whatever. A good attorney can say, hey, this is the same account and they can go after all of your money, not just your photography business money.

It's like you just kind of defeated the whole purpose of forming a separate company because you've been linked them. It's really important to keep a separate bank account for sure, and keep records of all of the money that goes in and out. I'm sure that's important from an accounting perspective, too, but at least from a legal perspective, you don't want anyone to be able to tie your personal bank account to your company account.