Publications: Articles Authored by Julius J. Brecht

To LLC, or not to LLC?
By Julius J. Brecht [1]
For The Alaska Journal of Commerce

So you are starting up a new business. What organizational form should you choose? Should you form as a sole proprietorship, corporation, partnership (limited or general), or perhaps as limited liability company?

More and more small businesses are forming as limited liability companies, not- withstanding the advantages and disadvantages of other business forms. For example, the LLC form is used by groups of doctors, engineers, and other persons offering professional services. It is also used by persons to accommodate specific business transactions.

Which form of organization chosen will depend upon your ultimate goal in starting your business. For example, forming your business as a sole proprietorship would allow you to exercise the greatest direct control of it and minimize interference with its operations from potentially pesky investors.

Alternatively, should your business plan require your seeking significant investment capital through an equity offering to others and with the intent of eventually having that equity traded on a stock market such as the Nasdaq Stock Market, the corporate form of organization would be the likely choice.

The corporate form has been in use around the country for over 200 years. There exists extensive case law interpreting multitudinous nuances of its organization, operation, and termination. It is simple in structure and operation. The owners (shareholders), who invest in the corporation, elect a board of directors. The board in turn adopts policy and gives direction to officers to carry out that policy.

Most importantly and unlike the sole proprietorship, the corporate form provides protection to the owners and their personal assets from liability for actions of the organization. However, with limited exception, a corporation is taxed as a separate taxable entity under the Internal Revenue Code of 1986, as amended. The result is that the income of the corporation is twice taxed-- once at the corporate level and again at the shareholder level on dividends paid by the corporation to them.

A corporation may apply for and obtain "S-corporation" status under that code, thus allowing direct pass through of tax consequences to individual shareholders. However, there are significant restrictions under the code as to who may become a shareholder of an S-corporation. Furthermore, the code limits the number of investors in an S-corporation to 35.

In organizing a partnership, favorable tax treatment similar to an S-corporation can be obtained. However, a general partnership offers no protection to individual partners from liability for the acts of the partnership. While a limited partnership does offer such protection to limited partners, that protection does not extend to general partners of the partnership.

What is needed is a hybrid organization which has the corporate characteristics of investor personal asset protection from liability for the acts of the organization and at the same time provides favorable tax treatment under the code. The LLC form has come to be a useful solution in Alaska and throughout the country.

The State of Wyoming provided an answer in enacting the first LLC statute a number of years ago. Other states soon followed. Such legislation first became law in Alaska in 1994 and was later revised as the Alaska Revised Limited Liability Company Act (AS 10.50).

Under the Alaska act, an LLC may be organized for any lawful purpose. However, the activity of the LLC or its purpose is subject to other provisions of law. For example, a group of one or more physicians seeking to practice their professions together must, in addition, be licensed physicians and meet other requirements as set forth in Alaska law.

The necessary organizing documents for an Alaska LLC are as follows:

• articles of organization
• operating agreement

In forming an LLC, the organizer must prepare and file articles of organization with the state. The articles must satisfy certain minimum content requirements set forth in the act. That is, the articles must state:

• the name of the LLC
• the purpose for which it is organized
• the mailing address of the LLC's registered office and the name of the LLC's registered agent
• if applicable, that the LLC will be managed by a manager
• other provisions for regulation of the internal affairs of the LLC consistent with Alaska law, should the organizers so elect

The Alaska act allows the organizer the flexibility to provide for management of the LLC by its members or by a manager. If management by a manager is chosen, the act provides that the manager may or may not be a member of the LLC as set forth in the operating agreement.

The operating agreement is, in many ways by analogy to corporations and partnerships, an amalgam of corporate bylaws and a partnership agreement. It typically addresses how the LLC is to be managed.

If the LLC is managed by a manager, provisions on manager election and terms of management are typically included in the operating agreement. Issues of duty of care, conflict of interest, loans to managers, if any, and indemnification of managers are also included.

The monetary relationship of the members is set forth through the ownership of LLC membership units and provisions establishing member capital accounts, and defining LLC profits and losses and their distribution to the members. Admission and withdrawal of members and termination of membership, as well as, dissolution and winding up of business are specified in the operating agreement.

An LLC interest (a membership unit) is included in the definition of a security as set forth in the Alaska Securities Act (AS45.55). Therefore, the offer and sale of an LLC interest must first be registered under that act unless there is a clear exemption from registration which applies to the proposed transaction.

There are other specific Alaska statutory requirements that need to be addressed before making an offer and sale of LLC interests. All of these matters must be taken into consideration before you hold yourself out to the public under the banner of your new business.

The prudent entrepreneur will carefully consider the organizational forms available for his or her new business. After weighing the advantages and disadvantages of them, the entrepreneur has the opportunity to select the one best suited to the goals of the business.

So, "To LLC" may be right for you, or perhaps "Not to LLC" may be the answer best suited to your business.

[1] Mr. Brecht is an attorney in private practice and shareholder with the law firm of Wohlforth, Johnson, Brecht, Cartledge & Brooking, A Professional Corporation, with offices in Anchorage, Alaska. Mr. Brecht's concentration of practice is in state and federal securities law and corporate and finance law. The content of this article was not prepared as, and must not be construed as, legal or investment advice to anyone. He may be reached at .

< Back to Articles Authored by Julius J. Brecht