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Subject: |
Setting Up A "Venture" Limited Liability Company The Right Way |
| Date: |
2009-02-02
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Setting Up A "Venture"
Limited Liability Company
The Right Way
By Cliff Ennico
www.creators.com
"Three friends and I are going off on our own to set up an information
technology consulting business. We want to form a limited liability
company for this business, but we want it to be flexible enough that we
can grow and attract venture capital investors. What are some of the
things we should be thinking about legally?"
Limited liability companies (LLCs) are very easy to set up when there
are only one or two people involved in the business, or the business is
not likely to grow rapidly (for example, a family owned retail or
service business). When people who aren't related and don't know each
other very well go into business together, things get a bit more
complicated.
Here are some of the things you and your friends should discuss before
committing to this venture:
Who Will Own This Business? Right off the bat I see a problem --
there
are four of you. If you divvy up the LLC ownership equally, you're
setting up a situation where if two of you want to "zig" and the other
two want to "zag", the LLC cannot function. We lawyers call that
"deadlock". Try to divide up the equity so that one or two of you own
51% or more of the LLC ownership shares (called “membership
interests”).
Who Will Run This Business? You should consider forming a "board
of
managers" to run the LLC business, similar to a corporation's board of
directors.
Three of you should serve as the "managers" of the business to avoid
"deadlock" situations. So the fourth person won't feel left out, you
can add a "supermajority voting" clause to your LLC Operating Agreement
(similar to a partnership agreement) requiring that the four LLC owners
unanimously approve major decisions affecting the LLC business (such as
the admission of a new member, a merger or acquisition, or investments
over a certain dollar amount). Your lawyer can provide you with a list
of common matters that are covered in a "supermajority voting" clause.
Capital Contributions. At some point, your LLC will need
additional
infusions of cash. If you do not make these "pro rata" (in proportion
to your respective LLC ownership percentages), then your percentage
ownership of the LLC will change depending on the amount actually
contributed by each member. To keep this from happening, consider a
clause in your LLC Operating Agreement requiring that any additional
infusions of cash be made in the form of "loans" - that way if one or
more members cannot pay their fair share, the others can make up for it
without changing the ownership of the LLC.
Compensation. Since all of you will be working in the business,
you
will want to make withdrawals from the LLC checking account from time
to time to pay your living expenses (called "draws"). Work out a
formula now as to how each of you will take "draws," or put a provision
in your LLC Operating Agreement requiring the members to vote
unanimously on "draws" each month.
Voluntary Withdrawal. If one of you has trouble meeting his
obligations
to the LLC, or comes under family pressure to "get a day job" if the
LLC business isn't providing him with a decent living, you will have to
figure out a way for him to "withdraw" from the LLC. You should agree
to pay him fair compensation for his LLC ownership interest if he
withdraws, but make sure (1) the LLC pays him over a period of five to
10 years so as not to burden the LLC’s cash flow, and (2) he or she is
bound by a noncompete clause not to steal business from the LLC or
otherwise compete unfairly with the remaining members.
Involuntary Withdrawal. If one of you dies, becomes disabled, is
divorced from his or her spouse, or files for bankruptcy, there’s a
chance a "stranger" will end up owning a piece of the LLC. Have your
attorney draw up a "buy-sell" agreement requiring the LLC to purchase
the ownership interest of any member who dies or becomes disabled, or
any person who acquires a piece of the LLC in a divorce or bankruptcy
proceeding.
As soon as possible after you form the LLC, the LLC should purchase
"key person" life insurance and "disability buyout insurance" on each
of the four owners (or those owners without whom the business couldn't
function). That way, if one of you dies or becomes disabled, the
proceeds of the insurance policy can be used to purchase his or her
ownership interest without impairing the LLC's cash flow.
Watch Out for Noncompetes. Since it appears some or all of you
are
leaving "day jobs" to start this new business, make sure you haven't
signed any "noncompete" or similar agreements with your current
employer. Even if you haven't, try to avoid contacting your employer's
customers, suppliers or employees for at least a year after you start
the new business.
Cliff Ennico (cennico@legalcareer.com)
is a syndicated columnist, author and former host of the PBS television
series 'Money Hunt'. This column is no substitute for legal, tax or
financial advice, which can be furnished only by a qualified
professional licensed in your state. To find out more about Cliff
Ennico and other Creators Syndicate writers and cartoonists, visit our
Web page at www.creators.com.
COPYRIGHT 2009 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE,
INC. Permission granted for use on DrLaura.com.
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