LLC Management - Part 2: Finances

One of the main purposes of forming and operating a limited liability company is right in the name – when the company’s operations are in good order, the owners (or “members”) of the LLC are shielded from any liability generated by the company.  A key component of ensuring this liability protection feature remains in place is maintaining proper financial management practices.

Comingling finances between a company and its members is one of the most common errors we see in LLC operation.  It is also one of the factors frequently cited by courts when they set aside the liability protection element of an LLC and allow creditors to reach the assets of the members, known as “piercing the veil.”  In order to avoid this, LLC finances must be kept completely separate from the finances of the members.  Below are some examples:

Bank Accounts - The LLC should have its own bank account, where company income is deposited and from which company expenses are paid.

Company Expenses - The LLC should only pay its own expenses, not personal obligations of its members or expenses of related entities.  When a company pays expenses that are properly treated as member expenses, it is an indication to the court that the members consider the company to be the “alter-ego” of the members rather than a separate entity with independent existence.

Capital Contributions - If the LLC requires additional funds, contributions by the members should be formalized as loans or capital contributions.  Money should not flow casually between an entity and its members and members should never pay company obligations directly from their own personal funds (or the funds of other, separate entities in which the member owns an interest).

Company Credit Cards - Company credit cards should only be used for expenses related to the company’s operations. Credit card payments should be paid from company funds.

Titling Assets - Assets that are used for an LLC’s business operations should be titled in the name of the company.  This includes real estate, office equipment, machinery, and inventory.  Any loans secured by company property should also be in the name of the company. Finally, purchase orders (both for the company’s purchase of assets and customers’ purchases from the company) should identify the company as the purchaser or seller, as the case may be.

It is easy for closely-held businesses to run afoul of these guidelines – we live in a busy world and sometimes it feels easier to just “take care of” a payment or purchase and sort out the particulars later.  But careful, rigorous money management is critically important because it help companies maintain liability protection for their members.  If an improper personal charge or payment is made in error, be sure to document it as an owner’s draw to be consistent with your tax-reporting obligations.  If you have questions about setting up proper financial systems for your new business, or getting an existing business on the right track, contact us for more information.

Click here to read our first LLC Management article about setting up your business.

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Estate Law  |  Business Law  |  Family Law

LLC Management - Part 1: Setting Up Your LLC

Welcome to the first of three articles in our series called, “Getting on the Path to ‘Best Practices’ for LLC Management.”

Many of our clients approach us with questions about managing their existing limited liability companies (“LLCs”) or forming new LLCs to manage their ongoing affairs.  This series of blog posts will address the basics of handling these entities in three parts – Setting Up Your LLC, LLCs and Finances, and LLCs and Recordkeeping.

Part 1: Setting Up Your LLC

The first steps of forming a limited liability company (or “LLC”) are relatively straightforward – you must file simple organizational paperwork with the State Corporation Commission.  This paperwork, called “Articles of Organization,” identifies (i) the name of the company, (ii) the purpose of the company, (iii) the identity and address of the company’s “registered agent,” and (iv) the address of the company’s principal office. When choosing a name for your company, keep in mind that there are two main features that are required for every LLC’s name.  First, it must be “distinguishable,” meaning that it is not identical or prohibitively similar to the name of an existing LLC.  The name must also include words or abbreviations that identify the company as an LLC, such as “limited company,” “limited liability company,” “L.C.,” “LC,” “L.L.C.,” or “LLC.”  Having a distinguishable name for purposes of forming the company is a separate issue from potentially infringing on another company’s name (say in a different state) for purposes of trademarks.  This takes a more exhaustive search and may be advisable depending on the name and where you will conduct business.

Today, most LLCs are formed online at the State Corporation Commission website, and therefore a generic statement that the company’s purpose is “any lawful purpose” is typically used.  Of course, people form these entities to transact various types of business, or even simply to hold assets.  Note that there may be reasons to organize your company as an entity besides an LLC (such as a corporation or partnership).  For more information on the differences between entity types, give us a call.

Your company’s “registered agent” is the person or entity that is formally listed as the contact for the company with the State Corporation Commission.  This is typically where any lawsuit against the company would be served and also where the State Corporation Commission mails annual renewal notices and other correspondence for the company.  Your registered agent can be an individual residing in Virginia who is a member or manager of the company, a member of the Virginia State Bar, or a domestic or foreign entity that is authorized to transact business in Virginia.  If your LLC has other entities as members, an individual with an interest in the entity (for example, a member of an LLC or an officer of a corporation) may also act as registered agent. 

Finally, the company’s “principal office” is the physical location where the company keeps its records.  Recordkeeping is an important part of successful management of LLCs (see the third installation in this series for more information), so it is critical that records are actually maintained at the principal office.

Once the Articles of Organization have been filed and the formation fee has been paid, you’re in business!  Typically, though, you’ll want to take one more step – signing an “operating agreement.”  The operating agreement is the contract that governs how an LLC will function and how the owners will coordinate running the company.  One of the most important decisions to be made when creating your operating agreement is who will manage the day to day operation of the company. LLCs may be “member-managed” or “manager-managed.”  Members are owners of the company; managers may be members, but are not required to be. Your operating agreement can also set out rules about holding meetings, admitting additional members, and financial contributions to, or distributions from, the company.  Absent an operating agreement, state law provides default rules that control the behavior and requirements of LLCs and duties of members to one another, so it is a good idea to create an operating agreement.  Every situation is different and chances are you will want to deviate from the default rules.  You may need an operating agreement for practical reasons, too – banks often require a copy of a company’s operating agreement before they will transact business with the company.  Finally, creating and abiding by an operating agreement is evidence that you take the company seriously, which can help others respect it if litigation ever arises (see the next post in this series for more on this topic).

You may also want to obtain a tax ID number (“EIN”) for the company.  If your company has two or more members, by default it will be taxed as a partnership (a “disregarded entity”) and will need its own EIN.  If the company is a single-member LLC, by default it is taxed as a sole proprietorship and is not required to have its own EIN.  However, it may still be convenient for the company to obtain its own EIN because the member may not wish to use his or her social security number to establish bank accounts, report income on W-2s, or distribute for purposes of 1099 reporting.   In addition to being taxed as a sole proprietorship, a single member LLC owned by one or more individuals can elect S Corporation status, in which case and EIN is required.   

With these steps, your LLC is ready to operate in the world as an independent entity. But there are continuing management steps you should take in order to make sure it continues to be considered separate from its members.For more information, keep an eye out for the next post in this series, LLCs and Finances. If you’re ready to create an LLC today, or have questions about managing your existing entity, we are here to help! Call us now to set up an consultation, 804.270.1300.

Our Practice Areas

Estate Law  |  Business Law  |  Family Law

The Family Cottage: How to handle your vacation property at death

Vacations are often an integral part of a family’s collective identity and experience.  As a result, our clients frequently ask for more specialized treatment of the family vacation home in their estate plan.  They envision their children, grandchildren, and even great-grandchildren returning year after to year to the same property for decades to come. 

That kind of continuity can be powerful and comforting, but as times goes on and the family expands, the management of this type of asset often becomes a challenge without specific planning techniques to resolve potential problems.  The major obstacles in the family’s ownership of a vacation home after your death are apportioning costs associated with the property and creating a system to determine who will have the right to access the property at any given time.

Clients often theorize that the costs of maintaining the family cottage will be split evenly among the oldest generation, which sounds simple and straightforward.  In reality, our lives are rarely this predictable, and there may come a time when one or more siblings will be unable or unwilling to contribute their share of the costs.  This can be the result of unexpected illness or unemployment leading to financial stress, but it may also be the case that one of the siblings is no longer interested in using the family cottage and prefers not to continue contributing to the costs.

Similarly, co-owners of vacation property may have trouble coming to a consensus about when each of them should have access to it.  Wherever the family cottage is located, there is likely to be a ‘peak season’ when access is the most desirable.  Families may also have limited availability, because school breaks for children often overlap and adults might have inflexible options for taking time away from work.

There are planning options that may overcome these hurdles, but we encourage you to first talk to your adult children and gauge their level of interest in the family cottage.  If only one child is interested (or has the means to maintain it), you can simplify your estate planning approach by leaving the property to the interested child and making up for the value using other assets that pass to the children who are not interested.  If none of your children want to take on the property, it is unwise to employ planning techniques that attempt to force it upon them.  Even “locked” in a trust, the children could petition a court to allow the property to be sold, and if forced to retain a property none of them want, they are likely to allow it to fall into disrepair, thus losing value.

If your children agree that the family cottage should remain accessible by all of them, there are several approaches that can minimize conflict.  Leaving real property outright to multiple people may not be the best strategy, because when co-owners of real estate cannot agree about costs or access, their only recourse is to file a “partition suit” with the court, requesting that the court force the sale of the property and division of the proceeds.  Disagreements of this kind, without a plan in place to address them, can lead to family estrangement – the exact opposite of what retaining the family cottage is meant to accomplish.  Another problem with this approach is that any creditors of one of the children (including ex-spouses) could attach his or her interest in the property to satisfy the child’s debt.

One better possibility is to form a limited liability company (or “LLC”) to own the property and leave your children membership interests in the LLC instead of ownership interests in the real property.  The terms of the LLC’s operating agreement could allow your children to buy each other out if one of them is unable or unwilling to continue contributing to the costs.  This type of entity also provides some creditor protection, as well as liability protection if the family intends to rent the property out during periods when it would otherwise be vacant in order to offset maintenance costs. 

Another option is to hold the family cottage in a trust that has specific terms spelling out the rights and obligations of the beneficiaries and setting conditions or a certain time when the trust terminates.  If there are concerns about cost-sharing, one possibility is to fund the trust with liquid assets (such as marketable securities) as well as the real property and directing the trustee to pay the maintenance expenses from the liquid assets.  If the trust is drafted properly, creditors of the beneficiaries of the trust would be unable to access the assets.

If you are an owner of a beloved family vacation home and have wrestled with how to transition ownership to your children at your death, give us a call.  We can talk you through the options and come to the best solution for your family’s circumstances.