(Published by the Idaho Business Review, May 2007)   

Today’s savvy construction business owners are choosing to run their businesses through legally organized business entities.  One such entity is a limited liability company (“LLC”).  Often owners chose an LLC based on some general recommendation from a third party (i.e., an attorney, accountant or friend) and know little or nothing about how this type of entity works. If you do not understand your LLC you cannot take advantage of all it has to offer.  More importantly if you are not aware of potential pitfalls, you cannot avoid them.  Following are a few important, and hopefully useful, pieces of information about your LLC.                   

Formation and Governance.  In Idaho an LLC does not exist until Articles of Organization are filed with the Idaho Secretary of State’s office.  Every year thereafter an annual report must be filed.  These are very simple documents and forms are available through the Secretary of State’s office and website, http://www.idsos.state.id.us.  Another important document associated with an LLC is the Operating Agreement, which has four (4) primary functions: (1) to provide a record of the organization of the LLC; (2) to provide a roadmap for the management of the LLC; (3) to restrict the transfer of the owner’s interest and provide for a smooth transition through events like the death, disability, divorce or bankruptcy of an owner; and (4) to modify the default rules set forth in Idaho’s statutes that would otherwise apply to the LLC.  Ideally, an Operating Agreement is executed by the owners at the time the LLC is formed, but it can be done after formation. 

Ownership and Management.  Owners of an LLC are called “members.”  Some LLC’s have “managers” as well.  If there are no managers, the members make all the decisions and have authority to act on behalf of the LLC.  If there are managers, the managers will have such authority as prescribed in an Operating Agreement if one exists, or by Idaho law in the absence of an Operating Agreement.  Idaho law provides managers extensive power to run the LLC so an Operating Agreement is vital for owners who want to place limits on the managers’ authority. 

Voting.  This is a broad topic, but one interesting point is that in the absence of language in an Operating Agreement stating otherwise, each owner of an LLC gets one vote regardless of whether it owns 99% of the LLC or 1% of the LLC.  This fact comes as a surprise to most LLC owners and, in many cases, is reason enough to have an Operating Agreement.  

Limited Liability.  While an LLC provides a business owner with some protection against liability, it does not protect against all liability.  An LLC generally offers protection from the negligence of another co-owner, but an LLC does not shield owners from individual liability for their own wrongs (e.g., negligence), or from inadequate supervision of employees or independent contractors.  Consequently, it is critical that the LLC obtain appropriate insurance to protect both the LLC’s assets and the assets of each owner.           

Guarantees.  Often lenders and credit providers will require owners to execute personal guarantees before credit is extended.  In the event any owner executes a personal guarantee, the limited liability aspects of the LLC will, as to that owner, be lost as to the debts covered by the personal guarantee.  LLC owners should keep careful track of all guarantees that they execute related to the LLC.  In the event an owner becomes disassociated with the LLC, that owner will want to actively pursue the release of its guarantee obligations.          

You are not “Partners”.  Co-owners of an LLC should refrain from referring to each other as “my partner” (even though the LLC may be taxed as a partnership, which I will address below).  Unlike owners of an LLC, partners in a partnership do not enjoy limited liability (except in the instance of limited partnerships).  Idaho law may determine that a partnership exists even though the “partners” do not intend for there to be one.  You do not want to unintentionally mislead anyone with whom you do business by making “partner” or “partnership” references.          

Taxation.  LLC owners can choose how they want to be taxed.  By default, the IRS views a single member LLC as invisible for federal tax purposes, but an owner can choose to be taxed as a corporation (in which case such an LLC will almost always elect to be taxed as an “S-Corporation”).  Multiple member LLC’s are generally viewed by the IRS as partnerships, but they can also make the corporate elections mentioned above.  Additionally, in Idaho (and other community property states), if an LLC is owned solely by a husband and wife as community property, the IRS can treat the LLC as a disregarded entity for federal tax purposes (just like a single member LLC).  The tax implications associated with LLC’s can be complex.  Business owners using the LLC business model should check with their accountant or tax consultant on decisions relating to the entity’s tax matters.            

In summary, an LLC can be a very useful tool for business owners.  However, like any other tool in your box, it can be worthless and even dangerous if you don’t know how to use it.