Five Common LLC Legal Mistakes

It’s very easy these days to find a company online to help you quickly “start a company,” and the most popular type of company is the limited liability company (“LLC”). Unfortunately, most people who use the services of an on-line filing company fall prey to some of the most common LLC legal mistakes.

This is because on-line filing services will gladly take customers’ money in exchange for completing rudimentary forms, and filing those forms at various state and federal agencies, while giving their customers the misleading impression that all of their legal needs in forming an LLC are being taken care of.

On-line filing services leave their customers with little guidance about how to properly finish structuring the LLC, and how to take care of all remaining legal requirements after the initial forms have been filed. This is especially true as to companies that are owned by more than one person.

This article addresses five of the most common LLC legal mistakes made by entrepreneurs, especially those who use on-line filing companies to form Oregon LLCs.

1. Not Drafting An Operating Agreement

The first step in forming an Oregon LLC is to file Articles of Organization. Most on-line filing companies give their customers the impression that filing the Articles of Organization is all that is required from a corporate law perspective. This may be the case in very limited situations, but most often much more is required, and a properly drafted Operating Agreement is one of the key additional documents.

Without a properly drafted Operating Agreement, an LLC is essentially a shell that is completely governed by the Oregon Limited Liability Company Act. The LLC Act is vague in many areas, leaving lots of potential questions for owners who may later run into legal issues. In that vein, the flexibility of the LLC Act is also one of its biggest drawbacks: flexibility is merely another way of saying that the LLC Act has no answers to some legal issues. If those issues aren’t answered, then when they later need to be addressed — for example, in the case when owners decide to part ways — there will be no clear resolution, and the LLC’s owners will pay a premium to lawyers and mediators to resolve the issues for them.

Examples of certain legal issues that owners — especially owners in multi-member LLCs — may consider addressing in their Operating Agreement include the following:

– Voting Arrangements
– Noncompete  and nondisclosure provisions
– Meeting provisions
– Members’ duties to the company
– Tax issues
– Transfer of ownership provisions (including rights of first refusal and triggering events)
– Value of the members’ respective ownership positions
– Deadlock provisions (especially in the case of 50/50 splits)

2. Not Electing the Proper Tax Status

Most entrepreneurs have never heard of the “check-the-box” regulations. These regulations allow companies to elect how they wish to be taxed. Single person LLCs are, by default, disregarded by the IRS, and the owner reports all of the taxes on his or her individual returns. Multi-owner LLCs are, by default, taxed under partnership tax law. However, whether as a single person LLC or a multi-owner LLC, the company can elect to be taxed under a different section of the tax code. These elections may have significant long-term financial benefits for the company, and its respective owners, and therefore should be considered at the outset.

3. Not Contributing Assets to the Company

When an LLC is formed, nothing is actually owned by the company. The Articles of Organization are the founding document, and they permit the company to exist as a separate legal entity from its owners. However, something has to actually be contributed by the owners, and that something can be tangible assets (e.g., cash, computers, cars, etc.) or intangible assets (e.g., trademarks, copyrights, patents, domain names, etc.).

To avoid later confusion about whether the assets were actually contributed to the company, the assets should be itemized in the Operating Agreement, and the owners should sign contribution and assignment agreements, pursuant to which they each assign the various assets over to the company so that it’s clear that those assets are the company’s property going forward.

4. Incorrect Use of Assumed Business Names

When a company is formed, it may only use its proper full legal name in business. For example, if a person forms “Acme Products LLC,” then only that name may be used. However, when the owners want to do business under a different name, they can’t simply start doing so. Instead, they must register that different name (the “assumed business name” or “doing business as” name) with the Oregon Secretary of State’s office. To learn more about that process, see this assumed business name article.

5. Not Registering with All Government Agencies

One of the most common mistakes made by Oregon LLC owners is the failure to register with all necessary government agencies and authorities. Those agencies, and registrations, may include the following:

– Oregon Department of Revenue (LLCs with employees must register, and workers compensation insurance is mandatory in Oregon)

– City of Portland / Multnomah County (All business located in the City of Portland or Multnomah County must register)

– Oregon Department of Justice (All new hires must be reported)

Oregon LLC owners will have plenty of other legal issues to deal with throughout the lifecycle of the company, especially if the company is successful. Those issues can be dealt with on a step-by-step basis, but the five common LLC legal mistakes above should certainly be avoided at the outset.