Limited liability companies (LLCs) are a hybrid (mixture) of corporations and partnerships. LLC law has combined the best aspects of corporations and partnerships. The three major advantages to LLCs are:
Before we begin the forms, here is basic information about how LLCs work, LLC restrictions and taxes.
Who and what makes up a limited liability company
Members: Owners of the company. This kit assumes that all members are active participants in the business and will have equal rights and privileges. If you have non-active participants or want certain members to have special privileges or priorities, work with an experienced attorney to customize an Operating Agreement to fit your needs.
Managers (optional): If the members choose, the day-to-day operations can be run by one or more managers. In these documents, we have assumed that the members will manage the business, not outside managers.
Employees: Anyone who works in the day-to-day operations of the LLC, under the control or supervision of the members (or managers, if applicable). Generally, members are not employees, even if they are involved in day-to-day operations. They are owners. However, there are exceptions. If you have a member whose work with the LLC is significantly greater than the other members, it is possible to treat him as an employee and pay a salary. Do not do this unless all the members have approved and you have consulted a tax professional.
Articles of Organization: The business' charter, which is filed with the State Secretary of State. It is a standard form which basically states that the company is in business as an LLC, lists the contact person for any legal actions, and states whether the business will be conducted by managers or by members.
Operating Agreement:: Operating guidelines for members and managers. State law requires an Operating Agreement, which may be verbal or written. This kit has a sample written agreement for a simple LLC.
Things to know about LLCs
Limited legal and financial liability for members
Members are granted limited liability, much like corporate shareholders. That means that creditors only have a claim on the business' assets to repay debts - not the member's personal assets.
Warning: Limited liability is not absolute. Just like corporate shareholders, members can lose the protection of limited liability if they:
Because LLCs provide limited liability, companies may be reluctant to grant credit to them. They often ask that a primary member "guarantee" payment. This means that if the company's assets cannot repay the debt, the member agrees to use his personal assets to repay it.
Even if you have to guarantee a loan, having LLC status is still beneficial because it will protect your personal assets from being used to pay for any non-guaranteed debts or for any legal claims. In addition, using an LLC form of ownership prevents you from being held personally (and potentially completely) responsible for your partner's actions, which is the major drawback from forming a partnership.
The IRS does not have an LLC tax status. When you file your SS-4 form, you will most likely choose to file federal forms as a partnership.
LLC law has been developed so that LLCs can avoid corporate (double) taxation, if certain requirements are met. These requirements are described below. The information and Operating Agreement are designed so that your LLC meets these requirements.
To remain an LLC and avoid being taxed as a corporation:
Your business must LACK two of the following four "corporate" characteristics:
Characteristic and what it really means
LLCs must choose not to do two of these four characteristics. Since limited liability protection is critical, that means that the LLC must have two of the following:
This is why the Operating Agreement in this kit contains:
All LLCs must:
Have an office which maintains the following books and records:
Can a husband and wife form an LLC? Yes.
LLCs cannot operate these businesses
LLC law does not allow LLCs to operate as:
The state does allow certain professions to form limited liability partnerships (LLPs). Contact your licensing board for complete information.
LLCs: take advantage of their flexibility
With LLCs you can have different member classes or members with different rights. As an example, your founding members can have voting rights, a percentage of profits and special perks. Later, you can add members with different (or no) voting rights or perks or profit share. You can give ownership options to employees for profits with no management or voting rights. You can also give minimum guarantees to certain members, delay distributions to others, or allocate tax losses in greater proportion to members who need tax write-offs.
If you want to take advantage of this flexibility, it is critical that you work with an experienced tax advisor, because the IRS does have certain restrictions that could significantly affect the taxation of the different classes of members. The Operating Agreement has only one class of members. You can amend it at any time with an attorney's assistance.
Revenue versus profit
The State Secretary of State must approve all LLC names. Many names are rejected because another company has already formed an LLC using that name. To avoid having your LLC papers rejected because of name problems, it is best to reserve your LLC name first.
Your name must satisfy 2 conditions
Your proposed LLC name:
If your true name is already taken in your state, contact the Secretary of State's office for assistance. Your business may have to be registered using a fictitious name at the state level.
Other businesses can use your name without LLC
Forming an LLC only protects your full legal name (with LLC) from being used as the name of another State corporation. If you want to protect your business name from being used by others, you should consider registering it as a trademark or a service mark. Simply registering it as a trademark however, is not sufficient. You must consistently and continually use the trademark and watch for, and notify possible infringes of your trademark. Please consult a business attorney for further information.
120 day deadline
Your name is reserved for 120 days. If your Articles of Organization aren't filed by then, you must start again, and re-reserve the name with the Secretary of State. The law requires that you wait one day after your name reservation has expired to re-reserve the name.
Articles of Incorporation are the basic charter for your corporation The original is kept on file with the State Secretary of State. The Secretary of State will stamp a file number on the original. This number should be used on all state tax payments and returns.
The Articles of Organization included here can only be used for LLCs which are not involved in the business and professions.
Articles of Organization must be filed within 120 days of reserving your Limited Liability Company name, or you will lose your rights for your reserved name.
Warning: Filing Articles of Organization triggers tax forms! If you won't be starting business until the beginning of the year, wait until the new year to file your Articles of Organization.
How to complete the form
Information you need
Officially, you are supposed to register your LLC in the state where you are conducting business. If you formed your business out of state, you will register as a "foreign" LLC.
If your name is already being used in your state or is misleading, you may have to register a fictitious name (dba) with the Secretary of State. Also, you will be asked to obtain a statement of good standing from the state in which your LLC was organized.
Call a business attorney or the Secretary of State's Office at
The Operating Agreement is the legal guideline for your company. You can obtain an operating agreement online, in an LLC formation book, from your attorney, or from the library. You can also create your own custom agreement by visiting your county law library and requesting the legal forms book for your state.
The role of attorneys:
Where to get an Operating Agreement
There are many sources for operating agreements: online services, LLC formation books, your attorney, and your local library. You can also visit your county law library (it is open to the public) and ask for the book of legal forms and create a do-it-yourself operating agreement. Here is a sample Operating Agreement provided by startupkits.com.
Before you can prepare an Operating Agreement, you must decide:
Will all your Members be entitled to the same privileges? Are all of your Members going to have the same management, profit, tax allocation, and voting privileges? If not, your LLC will have different member classes. This Operating Agreement has one member class. Please consult an experienced professional if you would like to use multiple member classes.
Will your members have different interests? This Operating Agreement allows you to give members different percentage shares of the LLC (e.g., Jane Doe gets 60%, John Doe gets 40%). A member's voting rights and share of profits and losses are proportionate to his or her interest in the LLC. Each member's percentage interest is documented in Exhibit A to this Agreement.
Voting This Operating Agreement assumes that the weight of each member's vote depends on his percentage interest in the LLC's profits. For example, assume an LLC with five Members, each with different percentage interests.
|Yes votes % of interest||No votes % of interest|
|Jane Doe 35%||John Macintyre 25%|
|Alice Waters 16%||Sandra Allen 13%|
|Mark McClure 11%|
|Total 51%||Total 49%|
|Yes wins 51% to 49%|
Value of non-cash contributions If any member is contributing non-cash (i.e. equipment, existing business contacts, future services, etc.) everyone must agree on the value of that contribution so that you will know what percentage interest that member is to receive. If someone is receiving a member interest in exchange for past or future services, there may be significant tax effects. Please consult a tax advisor.
Expectations of the members In this Operating Agreement you choose whether members must devote their full time to the LLC or not. It prohibits members from participating in competing businesses. If this is not acceptable to the members, contact an attorney.
LLC's financial needs Are the contributions by your members enough money to run the LLC for a year? Discuss what you might do if additional funds are needed.
Here is an example of what a typical operating agreement includes:
Operating agreements set forth the agreement on how the LLC will operate.
A member's capital account may only be decreased by:
The LLC should provide members tax reports by March 30 so that they can prepare individual tax returns. The LLC will keep a separate bank account. Any member (or list members) may endorse and deposit checks. The members shall determine who is authorized to sign checks. One member shall be designated at the LLC's tax representative to appear for any tax audits.
Members are not guaranteed to be returned any of their initial capital contribution.
Amending the Operating Agreement
In most Agreements, all members must approve any changes to the Operating Agreement. We suggest that specific language for any changes be reviewed by an attorney. If you are changing information from the original Articles of Organization, you must file either a restated Articles of Organization form or a Certificate of Amendment form with your state's Secretary of State.
Changing the Articles of Organization
Any changes in the Articles of Organization must be approved by members owning over 50% of the interest in LLC profits.
Extending LLC's life
After the end of your LLC's life (i.e. 25 years), the LLC will automatically dissolve. Members may vote to continue the business by filing a Certificate of Continuation form with the your state's Secretary of State.
Contact an attorney experienced in structuring LLCs.
Before signing the Operating Agreement, make sure everyone understands what being a member means. There are also two forms that need to be signed:
Forms to use
Before signing, are you complying with securities regulations?
Anyone who offers or sells rights to ownership in a business must comply with securities laws or face criminal and/or monetary penalties. Do not sign any document unless all members comply with securities laws restrictions. Violation of securities laws can expose you to personal liability.
Members are required by law to act in the highest good faith with the other members and not to obtain advantage through misrepresentation, concealment, threat, or adverse pressure. Members must also prove good faith and inherent fairness of any transaction from the viewpoint of the LLC.
What can be used to pay for membership?
In order to purchase a member interest in the LLC, people can pay the LLC in cash, in services rendered, in equipment, the assets of an existing business, or anything else the other members agree to accept. If cash is not paid, the members must agree on what cash equivalent value of their contribution would be so they can determine the percentage of profits and other owner rights that the member is entitled. Warning: If the person is paying in something other than cash, please consult with a tax advisor to determine if there are any tax consequencies.
Make sure that the total contribution from members provides enough capital for your LLC to operate the first year The biggest mistake new businesses make is to be under-capitalized. Be sure to evaluate your cash flow requirements - so you can pay bills even if your customers haven't paid you.
Membership means ownership
Remember that each time you issue a member interest, you are agreeing to divide the LLC's ownership and profits into smaller pieces. Furthermore, you cannot get rid of a member unless (s)he has violated the Operating Agreement. If you need cash but don't want to give up ownership, consider borrowing the funds and paying the loan back with interest.
Is your spouse a member?
Whether your spouse is a member primarily affects social security and settlements in the event of divorce. If your spouse is a participating member of your LLC, ideally both you and your spouse should be separate members with a percentage contribution (it does not have to be equal). This does not guarantee that in case of a divorce, the courts will allocate business ownership on the same percentage, because the state looks at what is equitable. However, it does show your original intent for ownership.
Both you and your spouse should talk with an attorney about this issue so that you both are in agreement.
Members can't freely sell their membership interest
To avoid being taxed as a corporation, it is critical that LLC members not be able to freely sell their member interest to others. According to the Operating Agreement, virtually any member withdrawal will cause the LLC to dissolve (section 7.1). Fortunately, members may vote to continue the LLC. New members may be admitted with the approval of all members. If a member withdraws, contact the Secretary of State to request a Dissolution and Continuation form.
Is there a membership certificate?
There is no piece of paper or certificate that is typically used to show an LLC member interest. Generally, member interests are shown in the exhibits that are attached to the LLC's Operating Agreement.
Purchaser's warranty and consent of spouse
Prior to becoming a member of the LLC:
Each member should sign a Purchaser's Warranty. This is required to qualify as an LLC. It states that the person is acquiring a member interest for their own use and does not plan to resell it.
If married, each member's spouse should sign a consent of spouse. This form assures that the spouse is aware of the member's involvement with the LLC and if the member wants to withdraw from the LLC, allows the other members to purchase their interest without further consultation with the member's spouse.
When can you add members?
After you organize, you may add new members to existing classes (i.e. they have the same rights as previous members) by following procedures in the Operating Agreement. If you want to add new members with different membership rights, please contact an attorney.
Can you offer more memberships later?
Yes. The Operating Agreement allows the existing members to determine the terms (price and conditions). If the new member has the same ownership interest (profits, management, voting and tax allocations) as the existing members, you must amend your Operating Agreement showing the new member's name. All members, including the new member, should sign it. You will also have to comply with securities laws and file a new securities form.
If the new member has a different ownership interest, please contact an attorney for the correct modifications to the Operating Agreement.
Questions? Call your attorney.
Corporations, limited liability companies and limited partnership are subject to the securities laws because they are offering ownership interests in a business. You must comply with federal and state securities laws or you will face criminal penalties including jail sentences and monetary fines. Federal and state securities laws are complex and require legal advice.
The big picture is that if you have owners in multiple states, you need to follow federal SEC rules. If everyone is in one state, you follow that state's rules. If ALL investors have full knowledge and are sophisticated investors (i.e. they are not investing their life savings in a get-rich quick scheme), you can be exempt from state filings. But if even one person doesn't qualify, your exemption will be void.
Please be aware that the law requires that purchasers be given full and accurate disclosure of all material aspects concerning the business they are purchasing an interest in.
Each city's business requirements vary. The following is a general description of these requirements.
Before you sign a lease or purchase equipment:
Verify that your proposed location complies with zoning requirements (including parking requirements and fire regulations).
Find out from the city building department if there are any code compliance issues.
If you are preparing food, talk with the County Environmental Health Department to verify that they will allow you to use existing equipment and facilities.
Usually you only need to get a zoning permit if you are changing the use of a building or if you are starting a home occupation business. Cities charge a nominal fee for home occupation permits ($50 is common). However businesses which want to change the existing use of a building may pay a fee, depending on the complexity of the request.
Most cities require anyone who conducts business in their city to obtain a business license and pay a business tax each year. The initial business license fee is usually the minimum business tax plus an administrative fee. In future years, the business tax is based on gross receipts, number of employees, or other criteria. The exact criteria depends on your type of business and your city's policies.
Home Occupation Permits
Home occupation permits are usually issued by the Planning (or Community Development) Department and are required before you obtain a business license. Business owners must agree to comply with the city's home occupation restrictions. These generally include:
Contact the Planning Department for a Complete List.
Many cities regulate the size, color, placement and number of signs you can display. This includes temporary signs and "sandwich boards" placed on the sidewalk. They may also require a building permit to install permanent signs. In general, home businesses cannot have business signs.
Other necessary permits
If you are making renovations or want to put a planter outside your door, chances are that you'll need a sign or building permit.
Commercial buildings are inspected annually by the fire department. This service is generally free except for restaurants, bars, theaters, and other places of public assembly, which may be charged an annual fire permit.
If you handle food in any way, you'll need a Health Permit. This is typically issued by the County Environmental Health Department.
Please contact your local city or county.
Many companies require their vendors to provide D&B, SIC or NAICS numbers before they will conduct business. These numbers are available at no cost.
Dun & Bradstreet is a private company which monitors business credit. They provide a free number to any business that is willing to wait 30 days. They also provide expedited Duns numbers and credit services on a fee basis.
To obtain a free D&B number, click here and enter your business ownership information.
Business credit is established through trade references, which are reported on a voluntary basis to a company such as Dun & Bradstreet. Usually, new businesses must wait a few months to start establishing credit. If you want to establish business credit with Dun & Bradstreet, you can provide references to Dun & Bradstreet, which they will verify to give you a credit rating. This is a fee-based service, and you must have 4 to 6 references which Dun & Bradstreet can verify. You can also improve your credit rating by providing D&B with information about contracts that you have received. For more information, visit http://www.dnb.com or call (800)234-3867.
Other resources available through the bookstore:
All about Credit
ABCs of Getting Out of Debt
Credit Repair Kit
SIC stands for Standard Industrial Code, which is a system that categorizes all products and services. The SIC system is being replaced by the NAICS system (below), but some companies still request an SIC number. To obtain an SIC number, go to http://www.osha.gov/pls/imis/sicsearch.html and enter your product or service. If you sell multiple products or services, you may have multiple SIC codes.
NAICS stands for North American Industry Classification System, which has replaced the SIC system to categorizes all products and services. To obtain your NAICS number (no charge), go to http://www.naics.com/search.htm and enter your product or service. If you sell multiple products or services, you may have multiple NAICS codes.
A patent is an exclusive right conferred by law to an owner of an invention to exclude others from making, using, or selling the patented invention for a limited time. The government grants this temporary monopoly in exchange for a full description of how to make and use the invention. The cost of obtaining a patent depends on the type of invention and the degree of complexity involved. To ultimately receive a patent, the owner of the invention will need to file a nonprovisional patent application. Roughly, the costs may range from about $5,000 to about $7,000 for an extremely simple invention (such as a golf training aid) to more than $15,000 for an invention involving highly complex technology (such as telecommunication technology). Some points to be aware of include the following:
Patents only protect you in the jurisdiction in which they are obtained. Therefore, a U.S. patent only prevents people from making, using, or selling the invention or a product that contains your invention in the U.S. If your patent has realistic market opportunities and high economic potential consider patenting it in other countries as well.
Be prepared to pay periodic fees to maintain your patent.
Patents are only valuable if they are valid and enforceable.
All these factors point to the reason that professional patent attorneys are usually hired. Despite that, you can do some of the work to lower your costs. See Resources below.
Before we Begin...a Warning on Scams
The U.S. Patent and Trademark Office (USPTO) warns all inventors to be wary of scams. Please read the following brochure before dealing with anyone other than the USPTO.
3 Types of Patents
There are three types of patents:
Utility: A utility patent may be granted to anyone who invents or discovers any new and useful process, machine, article of manufacture, compositions of matter, or any new useful improvement. For further information, visit http://www.uspto.gov/patents/resources/types/utility.jsp
Design: A design patent may be granted to anyone who develops distinctive visual ornamental characteristics for a manufactured item. The design must be a definite pattern or shape, applied to an article of manufacture. An example of a design patent would be a toothbrush manufactured to look like a spaceship, or an ornamental design for a cell phone case. For further information, visit http://www.uspto.gov/patents/resources/types/designapp.jsp.
Plant: A plant patent may be granted to anyone who invents or discovers and asexually reproduces any distinct and new variety of plant.
You can find out what patents have been filed that are the same or similar to your product by using Google's search tool.
You can search and apply for patents online at the Patent and Trademark website: http://www.uspto.gov/patents/index.jsp
Please remember that the wording (especially the claims) for patents is critically important to validity and enforceability and that a professional patent attorney should be consulted.
Providing a full and detailed description including drawings to your patent attorney can reduce cost.
Patent applications are carefully scrutinized and often rejected for revision by the USPTO. Thus, you should budget for prosecution expense (the "back-and-fourth" with the Patent Office) after your application is filed.
For questions, you can call the U.S. Patent and Trademark Office at: (800) 786-9199.
If you have written software (or have employees or independent contractors who have written software), please consult an attorney to discuss whether to patent, copyright, or obtain trade secret protection!
Trademark vs Service Marks
Trademarks are generally the words, logos, phrases and symbols used by manufacturers to identify the goods that originate from them. However, trademarks may also include sounds (e.g., the NBC chimes), scents (e.g., a fragrance for sewing and embroidery thread), colors (e.g. "pink" for insulation), and shapes (e.g., a silhouette of an "apple" for computers). Subject to limitations, almost any symbol, name, word, or device capable of distinguishing the source of goods may be used as a trademark.
Service marks are used to identify the source of the services of one individual or organization from those provided by others. Service marks and trademarks function in the same manner except that service marks identify the source of services rather than goods.
What to do
You can talk with an attorney experienced in trademark matters or do your own computerized search with help from your county or local law library. There are also professional search services that can do trademark database searches for you or your attorney (typical charge: $300 to $400 for a basic screening search).
Once you have researched the trademark for potential availability, the cost for filing for registration is about $1000 including attorney fees and fees to the U.S. Patent and Trademark Office. You cannot register a trademark unless it is being used in commerce (although you may apply for registration based on an "intent-to-use") and you will lose your trademark protection if you do not continue to use it in commerce. If you use your trademark in multiple states or serve customers in more than one state, you should register the trademark with the U.S. Patent and Trademark Office at: http://www.uspto.gov/trademarks/index.jsp. The trademark registration process can take close to a year.
Copyrights protect "tangible expression" such as that found in written documents, songs, recorded performances, computer programs, and art work (including advertising). The cost is very low (about $35 per application to register a work if you do it yourself online) and it is possible for nonprofessionals to do - although the more valuable your work, the more worthwhile it is to have an attorney involved.
Alternatively, a fee for filing an application for registration using paper forms is about $65. To request the appropriate paper copyright registration form, visit: http://www.copyright.gov/forms/.
Appropriate paper forms include:
The law is very strict on requiring written agreements if the copyright is assigned to another individual, a partnership, corporation or other entity.
The best practice is to consult with an attorney before commissioning any work or using someone's work.
Questions about the process or the forms? Visit http://www.copyright.gov/
The information herein should not be used or relied on as legal advice or opinion about specific matters, facts, situations or issues.
You should consult a lawyer about your particular circumstances before you act on any of the information contained in these pages because the law changes, can vary from jurisdiction to jurisdiction, and may not apply to your situation. This information is intended to assist you in understanding the basics of intellectual property law. It is not a complete guide and should not be considered legal advice.
Owning a business can often mean that if you get sick or injured, you get a double-whammy: the illness (with its expenses) and no more income. Insurance is extremely important.
The National Association of Insurance Commissioners have a tutorial which explains the forms of insurance and gives tips for evaluating insurance options. Go to http://www.insureuonline.org/smallbusiness/
Below are some basic forms of insurance. Only workers compensation is required by law. However, some landlords and businesses involving hazards will only conduct business with you if you have proof of insurance.
For theft or fire. Earthquake and flood protection must be purchased separately.
If you are sued by someone
Provides substitute income if your business is damaged from theft or fire.
Key person insurance and group life insurance:
Provides a lump-sum payment if a key person dies or cannot work anymore.
Home-Based business insurance:
Covers items not normally covered with a homeowners policy, such as inventory and office machines.
Covers you and your employees for work-related accidents.
Workers compensation insurance:
Required by law for businesses with employees. Pays for expenses and provides income if employees are injured while performing the job.
Pays for medical expenses (except expenses covered by workers compensation insurance).
Talk to an agent:
Every business owner should discuss their insurance needs with an authorized agent. In particular, home occupation businesses should review their homeowner's policy to determine whether that policy covers their home business.
If you have employees, you are required by law to carry workers compensation insurance. However, this insurance is generally not available to business owners. Instead, sole proprietors and partners must carry their own health and disability insurance.
Ask vendors for certificate of insurance:
Before you conduct business with others - especially if they will handle your products or will perform a potentially hazardous job (even driving a car), ask them to provide you a certificate of insurance from their insurance carrier.