You have options for your LLC needs. In recent years, these options include a multitude of online filing services that offer “LLC formation services” at increasingly lower costs. Many cash-strapped business owners turn to these online providers for LLC formation. Some are left with the mistaken impression that the simple online filing is enough to accomplish their legal objectives, only to find out later that the LLC formation service simply filed a fill-in-the-blank form that they could have filed themselves.
LLC formation is not as simple as online providers would have you believe. LLCs are formed by a simple online filing—which, as explained below, most founders can easily complete on their own. But LLCs are governed by the terms of their operating agreement and any related organizational documents. Although state LLC statutes provide a patchwork of default rules as gap-fillers, these rules were intended to be fallback provisions. State LLC statutes mostly defer to the operating agreement to define the rights and responsibilities of the owners.
Most LLC providers simply file a form with the state and, at best, provide a simple boilerplate operating agreement that is not customized to your situation or designed to accomplish your legal goals. The result is an LLC that is technically “formed,” but may provide little to no legal benefits.
Do You Really Need an Attorney to Form an LLC?
This article explains why most people actually need an attorney to form their LLC. But before going too far, let’s address the elephant in the room: It is hard for LLC attorneys to explain their value proposition without sounding self-serving. When attorneys point out deficiencies with online filing services, many business owners suspect that these attorneys only take that position to line their own pockets, as though their only objective is to squeeze money out of the business owners.
It is true that attorneys have a financial stake in convincing you that they provide the right solution for your LLC formation needs. But that does not, of itself, make them wrong. And online LLC formation services also have a financial stake in convincing you that the results you achieve with their service are comparable with those an attorney could provide. That is simply not the case. The rest of this article explains why.
What Does it Mean to “Form” an LLC?
LLC formation is not as simple as online providers would have you believe. LLCs are formed by a simple online filing (which, as explained below, you can do yourself).
An LLC is formed when a form is filed with the Secretary of State of the state where the LLC will be formed. This form—called a certificate of formation, articles of organization, or organizer’s statement, depending on state law—formally establishes the existence of the LLC with the state. Once the form is filed and the filing fee paid, the LLC is technically “formed.” But what does this accomplish?
You decided to form an LLC for reasons. These reasons could include limiting your liability for debts and obligations of the business, providing clear rules for how the business will be operated, saving money on taxes, or establishing professionalism and credibility when dealing with third parties. If your business has multiple owners, the LLC may also be formed to provide a way for you and the other owners to join together in the business.
Simply filing a certificate of formation does not effectively accomplish these objectives. If you are simply looking for bragging rights that you have an LLC, filing the certificate of formation provides that. But if you want to accomplish the business purpose and legal objectives for forming the LLC to begin with, more is needed.
At a minimum, your LLC needs a customized operating agreement (called a company agreement in Texas) that is designed specifically to fit the unique profile of the business. Drafting an operating agreement requires analysis of a multitude of legal and tax issues, many of which could be critical to achieving optimal legal protection and tax benefits. An operating agreement deals with important issues such as:
- Does the LLC structure provide optimum protection from both inside and outside liability? Should a trust or other owner be added for asset protection reasons?
- Will the LLC be involved in multiple lines of business? If so, should the LLC use a holding company structure or a series LLC structure?
- What is the most tax-efficient tax classification for the LLC? Should it be taxed as a sole proprietorship? As a partnership? As a C corporation? As an S corporation?
- How should LLC profits be distributed? Are there provisions in place to protect against the possibility of phantom income?
- How will new members be admitted to the LLC? This question raises key asset protection concerns. If a member files for bankruptcy, could a bankruptcy trustee become a member and force liquidation of the company? The operating agreement should be clear on that issue.
- Are there minority and majority interests? Minority and majority owners often have concerns and objectives that differ from each other, and equal ownership presents the possibility of deadlock over key decisions. Each of these scenarios should be addressed in the operating agreement.
- Are any of the members married? If so, state law may give each married owner’s spouse an interest in the LLC. For example, community property states like Texas give the spouse an interest in the LLC in most circumstances. The LLC operating agreement should be drafted to deal with spousal ownership, either by requiring the spouse to agree to the agreement or by converting the spousal interest to separate property.
- What is the correct management structure for the LLC? Should it be member-managed or manager-managed?
- What are the voting rights of members? Should supermajority or unanimous vote be required for certain company actions like company liquidation or sale of assets?
- What are the owner’s plans for exiting the business? If it is a closely-held business that the companies will operate on a long-term basis, are there buy-sell provisions to deal with the eventual death, disability, or retirement of an owner? If the company could be sold, are there drag-along or tag-along provisions to facilitate a sale of all of the company equity? Will there be rights of first refusal or preemptive rights?
- Does the LLC have the right to make capital calls or require mandatory loans from members? If so, the capital call and loan provisions must be carefully drafted to avoid creating unlimited liability for company obligations.
- How can a member withdraw from the company? Can a member be expelled?
- What are the procedures for transferring a member’s interest? Can interests be assigned? Does assignment confer voting rights or the ability to participate in management?
Simply filing a certificate of formation does nothing to address these and other important issues. Business owners that think otherwise may discover too late that the “LLC formation service” they used did very little to provide them with legal protection.
The ultimate test of an LLC is whether it holds up when it is needed. If one of your goals is to protect yourself from personal liability, then the test of the LLC is whether it provides that protection when you are sued. Likewise, if a goal is to help resolve potential conflicts between owners, the test will come when the owners reach a disagreement about a key business matter. Good LLCs attorneys know the law and understand the legal strategies for designing LLCs that do what you need them to do.
The Truth About Non-Attorney LLC Formation Services
Online filing services often conceal their costs. Many add fees at a later date or sign you up for recurring billing that is difficult to cancel. Others offer online filing as a loss leader to sign you up for registered agent services that require separate filings with the Secretary of State to cancel.
Most online filing services take advantage of consumer ignorance. They offer “LLC formation services” that consist primarily of filing the certificate of formation with the state. This leaves the business owner with the impression that filing the certificate of formation is a “good enough” solution that provides adequate legal protection. That is not the case.
The truth is that you do not need an online filing service to file a certificate of formation with the Secretary of State. Most state LLC formation forms are short, relatively simple fill-in-the-blank PDF files with instructions on how to complete them. For example, the Texas LLC Certificate of Formation (Form 205) is a three-page form with three pages of instructions. The instructions tell you everything you need to know to complete the form and provide contact information for common questions (like ensuring that the name of the LLC is available).
If your goal is to form the LLC at the lowest cost, you probably could complete and file a certificate of formation in minutes. You do not need an online filing service to do it for you. You simply complete the form, then mail it to the state with the appropriate filing fee. Filling out the form yourself allows you to form the LLC at the lowest possible cost (just the filing fee). But, as described above, filing the certificate of formation is the bare minimum required to establish the LLC. It does not address the important issues involved in LLC formation and should not be relied upon to accomplish your legal and business goals.
Why You Need an LLC Formation Attorney
You need an LLC attorney because you do not know what you do not know. LLCs are the most flexible form of business and can accomplish many objectives mentioned above, but only if they are properly formed and operated. Most people are unfamiliar with the wide range of legal and tax issues involved in LLC formation. Only attorneys are qualified to provide the legal analysis and tailored documents to protect you from liability and accomplish your legal goals.
Online filing services are, by definition, not attorneys. They have no legal training and do not understand the legal and tax implications of how LLCs can be structured to accomplish your legal and business goals. This is why they are prohibited by law from providing legal advice.
Attorneys can provide guidance on important matters, including the issues mentioned above and dozens of others. If you understand the law well enough to decide these matters for yourself and draft an appropriate operating agreement that adequately addresses them, then perhaps you don’t need legal advice and can get by without an attorney. Otherwise, an attorney is the best option for forming an LLC that accomplishes your legal and business objectives.