New business owners routinely form limited liability companies, “LLCs,” when starting their business. And with good reason – LLCs limit their owners’ liability, are not double-taxed, and are easier to form than corporations. But just starting an LLC doesn’t guarantee you’ll reap those benefits. This post describes common pitfalls that can immobilize an LLC or even expose a business owner to personal liability for the LLC’s debts.
Pitfall #1: Skipping the Operating Agreement
Every North Carolina LLC files “Articles of Organization” listing the LLC’s name, address, and registered agent. But many LLCs skip the critical step of preparing an operating agreement.
An operating agreement is an LLC’s constitution. It allows the LLC’s owners to decide how ownership is split, how responsibilities are shared, how profits are disbursed, and how to add – or kick out— company members. Without one, an LLC is stuck with the default rules of North Carolina law, which could be markedly different from the owners’ intentions. When disputes arise between co-owners, an LLC can become deadlocked and unable to operate. Drafting an operating agreement before disputes arise is critical to ensuring an LLC avoids deadlock and operates as the owners intended.
Pitfall #2: Omitting the Company Name in Contracts
Some LLCs are a one-person shop: the owner is the sole employee and deals directly with clients and creditors. In those cases, LLC owners should pay special attention that their contracts list the LLC – not its owner – as the contracting party. An LLC only shields its owners from personal liability if the LLC is the one doing business. Owners should be vigilant that company documents such as contracts, invoices, and letterhead list the LLC, and only the LLC, as the contracting party. Otherwise, you may have just exposed yourself to personal liability.
Pitfall #3: Missing Annual Reports
Once a year, LLCs must file reports with the North Carolina Secretary of State containing the LLC’s current contact information and list of officials, plus a filing fee of $200. Failure to file an annual report eventually results in the “administrative dissolution” of your LLC. An administratively dissolved LLC cannot do business until it is reinstated. That means it cannot enter contracts – leaving you seriously exposed if an issue arises while your LLC is dissolved. To avoid this issue before it arises, make sure that your LLC promptly files its annual reports each year.
Pitfall #4: Ignoring Corporate Formalities
One of the worst mistakes a business owner can make is to treat an LLC as a financial extension of themselves. The law considers an LLC to have a separate existence from its owners. Failure to respect that separation opens the door for creditors and legal adversaries to “pierce the corporate veil” in a lawsuit and access your personal assets.
To ensure your LLC keeps a separate existence, you should keep your LLC adequately capitalized. That means the LLC should be more than a shell – it should have enough assets on hand to cover ordinary expenses. Business owners should also follow corporate formalities and refrain from using the LLC’s accounts as a piggy bank to cover personal expenses. These steps keep the LLC, and its liability, separate from you individually.
An LLC properly maintained is a powerful tool for business owners. By avoiding these pitfalls, you can ensure you’re getting your money’s worth from your LLC.
Blanco Tackabery regularly assists businesses, including LLCs, in a wide variety of corporate and litigation issues. If you are a business owner, we are ready to help you understand everything you can do to maximize your business’s legal protection.
Ryan Dovel works with the Intellectual Property Practice Group at Blanco Tackabery. Harnessing his experience as a law clerk at the North Carolina Business Court, Ryan represents individuals and businesses in civil litigation. In addition, he practices in other areas such as municipal law, and fiduciary litigation.