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Start a Business Articles and Resources

The Top 12 LLC Advantages and Disadvantages

by | Jul 1, 2015 | , , , , ,

When looking to start a business or protect investments you have several options in the type of entity you can form. As with anything, there are advantages and disadvantages to limited liability companies.

Advantages

  • It limits liability for managers and members.
  • Superior protection via the charging order.
  • Flexible management.
  • Flow-through taxation: profits are distributed to the members, who are taxed on profits at their personal tax level. This avoids double taxation.
  • Good privacy protection, especially in Wyoming.
  • This is a premier vehicle for holding appreciating assets, such as real estate, stock portfolios, and intellectual property.
  • Extraordinary flexibility in the ability to allocate profits and losses to members in varying amounts.

Disadvantages

LLCs and the Charging Order

One of the great asset protection advantages of the LLC is the charging order.

Charging order protection arises from each state’s law and is a key strategy for shielding your assets from attack. As with anything in the law, the charging order is subject to change and interpretation by the courts. Some states view the statute differently than others, which is why it is important to choose the right state when forming a limited partnership (LP) or limited liability company (LLC). It is also important to keep up on the new court cases and trends in this area to keep yourself better protected. Remember, the LLC has only been widely used in the USA in the last 25 years or so. We are just now starting to see court cases defining their scope and use.

Going back to the original statute (the rule passed by each state’s legislature) we consider section 703 of the Uniform Limited Partnership Act. It states that if a partner of an LP owes money to a judgement creditor (one who has gone to court and prevailed) the court may order a ‘charge’ against the partner’s interest to pay the judgement creditor. Thus the term ‘charging order’. This rule also applies to LLCs.

For example, if John owns a 50% membership interest in XYZ, LLC and John owes money to Mary after losing to her in court, Mary can seek a charging order to receive John’s 50% share in the distributions from XYZ, LLC. Of course, John’s other partner Carlos is not as keen to this, but any disruption is minimized with the charging order. Mary does not step into John’s shoes as a substituted partner. She can’t vote and tell Carlos how to run the business. Instead, she is only assigned the distributions that would have been made to John.

Again, the charging order is a court order providing a judgement creditor (someone who has already won in court and is now trying to collect) a lien on distributions. A chart helps to illustrate our example:

illustration of charging order

In our example, John was in a car wreck which injured Mary, the other driver. Mary does not have a claim against XYZ, LLC itself. The wreck had nothing to do with the duplex. Instead, Mary wants to collect against John’s main asset, which is a 50% interest in XYZ, LLC. Courts have said it is not fair to Carlos, the other 50% owner of XYZ, to let Mary come crashing into the LLC as a new partner. Instead, the courts give Mary a charging order, meaning if any distributions (think profits) flow from XYZ, LLC to John then Mary is charged with receiving them.

Mary is not a partner, can’t make decisions or demands and has to wait until John gets paid. If John never gets paid, neither does Mary. The charging order not only protects Mary, but it is a useful deterrent to frivolous litigation brought against John. Attorneys don’t like to wait around to get paid.

This short video also explains the charging order:

But what if there is only a single owner?

The Difficulties of Single Member LLCs

In a Single Member LLC, there is no Carlos to protect. It’s just John. Is it fair to Mary to only offer the charging order remedy? Or should other remedies be allowed?

llc advantages and disadvantages charging order single member llc

A key issue is whether the charging order applies to a single member (one owner) LLCs. There is a nationwide trend against protecting single member LLCs with the charging order. Courts are starting to deny single owner LLCs the same protection as multiple member LLCs. The reason has to do with the unique nature of the charging order.

In June of 2010, the Florida Supreme Court decided the Olmstead vs. FTC on these grounds. In a single owner LLC there are no other members to protect. The court allowed the FTC to seize Mr. Olmstead’s membership interests in order to collect. Other states have followed the trend.

How Corporate Structure Can Increase Protection

Say you have a property in Oregon. That property is entitled to an Oregon LLC, which is owned by a Wyoming LLC. You then invest in a property in North Carolina, so you set up a North Carolina LLC owned by the Wyoming LLC.

If a tenant of your Oregon property sues over something that happened on the property, they have a claim against the Oregon LLC, not against you personally. They can’t get at your North Carolina LLC, and they can’t get at equity held on your personal property.

As you can see it’s beneficial to spread your properties across multiple LLCs. If you have 10 properties all in one LLC, it becomes a target-rich LLC. Often, we recommend only having one property per LLC. You may wish to have two or three properties in an LLC, but it really depends on how much equity you have in each property. The structure of your business really comes in to play during an inside attack, which is where the lawsuit is against an LLC, not the owner.

In the case of an outside attack, where the owner of the LLC is the target of a lawsuit, the charging order comes into play. In our example above where Mary is trying to get at John’s property, let’s assume John is the owner of a Wyoming LLC, and he has LLCs in North Carolina and Oregon. The car wreck has nothing to do with John’s Wyoming LLC, the holding in Oregon or the holding in North Carolina, so Mary can only go after John. And since John has a Wyoming LLC, even if he is the sole owner of the Wyoming LLC, Mary’s only option is the charging order. If the Wyoming LLC makes no distributions, Mary gets nothing. If the Oregon LLC and the North Carolina LLC make no distributions to Wyoming, Mary gets nothing.

This is not a great situation for attorneys who are on a contingency fee. They get a percentage of what is collected and it’s not a really good way to operate if they have to sit around get a charging order against the Wyoming LLC and then sit around and wait to get paid. Attorneys, being rational, economic animals are going to take the next case that has insurance instead of waiting for John to pay Mary.

You want to use the strategic positioning of the Wyoming LLC, which will own all your other out-of-state LLCs. States like Oregon and North Carolina may not protect the single member LLC, so you really need a Wyoming entity for protection in a case like the car wreck example. The Wyoming LLC creates a firewall against attorneys and frivolous lawsuits.

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How To Present Your Business Plan

by | Jan 8, 2015 | , , ,

Business plans are meant to be seen. Whether you wrote your plan to attract funding or to help with management, you will need to show the plan to someone.

If you wrote your business plan in order to attract funding and/or investment, you will need to get the plan into the hands of the people who can decide whether or not to give you money.

Most of us are uncomfortable when it comes to talking about money. Many of us were taught that it is rude to talk about something so crass. But if you want someone to give you a loan or invest in your company, you will have to get over your upbringing because you can’t just mail out your plan and hope for the best.

If you want loan or investment approval you will need to take meetings and present your plan. Don’t think that just having the meeting and leaving the plan for the decision-makers to read will cut it. Don’t leave something as important as your business’ future to chance. Decision-makers may promise to read your plan and give it consideration, but you can’t be sure they actually will. The only way to be sure that your potential investors or lenders get your message is to present it.

The presentation of your business plan should be a business meeting, a formal presentation. Even if the potential investors are your parents and your little brother, you want to present your plan in a serious and professional manner. (Remember, although the law may change, you can’t advertise for people to come to this meeting.) But for your pre-existing audience, your friends and family and any professionals you’ve been in touch with, you may want to use a conference room. This room can be at the potential investor or lender’s office. If not and you lack the facilities, try borrowing space from a friend or renting a conference room. You may want to use presentation equipment, such as a computer/projector for your PowerPoint presentation. You should give your audience hard copies of your plan as well. When is up to you.

You can have the plan delivered before the meeting so that your audience will have time to formulate questions, though you run the risk of them making a negative decision before you have a chance to highlight all your positive points. Try having the plan delivered just the day before the meeting so your audience can become familiar with the plan, but it unlikely to make a decision. Or you can hand out the plan at the beginning of the meeting, though you run the risk of your audience reading while you are trying to present. Either way, have copies of your presentation slides to hand out so your audience can follow along.

Your slides and their corresponding handouts should be short, ideally bullet-points, and be in the same visual style as your plan. Your presentation should be less formal than your plan in that you don’t want to just sound like you are reading. Try to make it as much like a story as you possibly can. Practice your presentation and get feedback from people you trust to give you honest opinions before you go before people who can make or break your business. Keep in mind that your audience can read – your slides and your handouts – so you don’t have to. Let your slides be reminders for your talk. Let them remind you what points you want to make and then expand from there.

If you wrote your business plan to aid in management, who sees the plan will depend on your business, your style and your goals. Obviously, if the whole business is comprised of you and your spouse, there don’t need to be a lot of secrets. But if yours is a business with a rigid hierarchy with decisions made only at the top level, you may want to limit access. You may choose to share your plan with management only or show employees on a need-to-know basis. You might distribute a version of the plan (say, a version without financial detail, but perhaps with graphs and percentages instead) or you could include sections of the plan in your employee manual. It is entirely up to you. Odds are you will need to consider the twin needs of protecting sensitive information and building a sense of ownership and only you know how to do so.

While people involved with money will have a pretty good idea why you are showing them your business plan, employees might not. You might include your business plan presentation as part of a company retreat or have a special meeting just for the plan. Maybe you want to introduce the plan to everyone at once or department by department. Wherever you choose to have your plan unveiled, be sure you are present. You may choose to deliver the entire message yourself or you might be better served using a team approach with appropriate managers discussing different sections. Again, it comes down to your particular approach and your particular business. Regardless, be sure to explain what a business plan is and how it should be used, why you are showing it and what you expect listeners to do with it. Similarly, if you use the plan as part of your training program for new employees, be sure that they are not just handed the plan cold, but are given the same message you gave the others.

As your business and your business knowledge grows, take some time to check back in with employees to see how the plan is being used and how employees feel it is working. Get suggestions and comments from employees and then use that input to improve the plan. Let the plan work as a road map, a checkpoint and a management tool. For more information on this topic, please read my book Writing Winning Business Plans.

Writing Winning Business Plans

Writing Winning Business Plans 4To win in business requires a winning business plan. To write a winning business plan requires reading Garrett Sutton’s dynamic book on the topic. Writing Winning Business Plans provides the insights and the direction on how to do it well and do it right.

Rich Dad/Poor Dad author Robert Kiyosaki says, “The first step in business is a great business plan. It must be a page turner that hooks and holds a potential investor. Garrett Sutton’s Writing Winning Business Plans is THE book for key strategies on preparing winning plans for both business and real estate ventures.”