Many small business owners are familiar with a business entity called the “limited liability company,” or “LLC” for short. Although it is not a blanket solution for every business, many small business owners like the ability to manage their entity without all of the corporate formalities. The formalities that generally go hand in hand with incorporation, while enjoying the limited liability protections that corporations have and that sole proprietorships and general partnerships do not.
However, many small business owners who create LLCs are unaware of the ability to create a Series LLC. Just what is that? Think major corporations, with their wholly owned subsidiaries, on a smaller and simpler scale. The LLC is governed by a “company agreement” or “operating agreement” that sets forth how the LLC shall be run, as well as rules or bylaws that apply to each series, which operates separately as its own entity, much like a corporation’s subsidiaries. Sounds a little complicated, so why would you want to do that? Well, here are three good reasons why it might be right for your business:
- Increased Limited Liability Through Asset Isolation.Let’s start with the basics. Bob Smith starts a small business, which he runs as a sole proprietorship. The business fails, the office closes and is no longer active. Bob, however, as a small business owner, or former small business owner, is still liable for the debts of his failed business. His creditors can sue him and get a judgment against his personal assets even though he’s no longer in business. Bob has to file bankruptcy to eliminate the debt.Fresh out of bankruptcy, Bob decides to start a new business. Now, rather than operating it as a sole proprietorship, Bob creates an LLC, a limited liability company. If Bob’s new venture fails, Bob can shut down the LLC, and Bob isn’t liable personally for the LLC’s debt (unless he personally guaranteed it).
A series LLC takes limitation of liability to a whole new level. Let’s say Joe and Bill decide to open a restaurant, often a hit or miss proposition. They create a traditional LLC to give them limited liability. The restaurant does well, so they decide to open a second location. However, the second location doesn’t do nearly as well, and the second location is closed. The second location doesn’t have enough money after closing to pay for the ongoing lease of the restaurant site or to finish paying off all the equipment and furnishings. Although Joe and Bill aren’t personally liable for the debt of the LLC, the LLC is liable for the debts of the new location and for failing to pay for all new location’s equipment and supplies. These debts threaten the original location, which now may fail to survive under the obligations incurred by both locations.
If Joe and Bill had created a Series LLC instead of a traditional LLC, they would have had much better protection through the isolation of the assets. This happens in several ways. The first way is by vertical isolation. Again, think of a corporation and its subsidiaries. The Series LLC acts like the “mothership,” owning the name of the restaurant, and has its own assets. Let’s call the venture “Good Grub, LLC.” The first location is handled by creating the first “series” which is its own entity for liability purposes. The first series, which we’ll call “Good Grub, LLC – series 1” signs the lease, orders supplies, hires the staff and operates the first location. If Good Grub, LLC – series 1 can’t pay those bills, the main entity, Good Grub, LLC isn’t liable. It can try again in a new location, and the assets of the parent aren’t liable for the debts of the series.
The second way Good Grub, LLC can have better asset protection is through horizontal isolation. Let’s go back to where we started. The first location, now run as series 1, is successful, so Good Grub, LLC’s owners, Joe and Bill decide to open locations 2 and 3, but they do so by creating Good Grub, LLC, – series 2 and Good Grub, LLC – series 3, each of which operates as a separate entity. Now if at one of it’s locations, Good Grub’s grub isn’t so good, and the one location closes or it’s customers get food poisoning and all sue, the other locations, run through separate series, aren’t liable for the debts of the “bad grub” location.
Now that’s a lot of asset protection for operating a series LLC, which isn’t much more involved to run than a traditional LLC.
- Increased Flexibility Among Members.
Let’s stick with our restaurant owners, Joe and Bill. Let’s say they create a traditional LLC, each owning a 50%-member-share. Location one is successful, so they think about opening location two. But what happens if either Joe or Bill, or both, are short on the capital needed to open the second location? If a loan isn’t feasible, now they’ve got to add a new member to their existing LLC, or create a new LLC to own the new location. But now we’ve got issues as to which LLC owns the right to the name, along with a host of contractual issues.
A series LLC creates much more flexibility. If Joe and Bill don’t want to have the new member, Ralph, have an ownership interest except in location 2, they can specify that he only owns say, a 30% interest in series 2. Now profits from location 1 are split 50-50 between Joe and Bill, but profits from location 2 are split 35-35-30. Now they want to open location 3, but Joe is putting kids through college. They can agree to open and fund series 3, but for this one, Joe will only have a right to 10 %, for example, with Bill and Ralph splitting the remaining 90 % in whatever way they chose. Any member can say “I’m out” for any location, or they can reach a different agreement for each series. They can still be “partners” (only in the loosest sense of the word) but they don’t all have to place the same bet on each new location.
- Enhanced Gifting Ability.
Another advantage of operating as a series LLC is increased flexibility in making gifts to children and other relatives. Maybe Joe wants to bring his children into the business. He may not want to bring each child into the whole enterprise, but let’s say he has 100% ownership, 3 children and 6 locations. Rather than giving each child an interest in the entire business, maybe he starts out each child with an ownership interest in the location where that child starts working. He can organize a plan where each child eventually runs his or her own “show” instead of having all three grappling for control of the entire enterprise. The primo location can be paired with the laggard location to equalize gifts to children, while the other two split up the middle ground in whatever way Joe thinks is the fairest.
Maybe Joe isn’t thinking of his children at all, but he wants each location manager to have an ownership stake in the location that manager runs. By using a series LLC, he can give that ownership stake in a separate series without having to gift an ownership interest in the entire enterprise.
These are just a few reasons why small business owners might prefer to organize as a series LLC. And for all these potential benefits, the cost isn’t much more than operating as a single traditional LLC, and certainly less expensive than creating a new LLC for what could otherwise be created as a separate series. Of course, there are also tax consequences to consider, and the laws of some states don’t provide for the creation of series LLCs under their own statutes. So, while you should always consult a professional in these areas, a series LLC just might be right for you.