III.General Questions About the Llc and the Members

MEMORANDUM

To: / Clients who are considering forming multi-member LLCs
Date: / February 28, 2014
From: / John Cunningham
Subject: / Issues you should consider in preparation for our meeting to discuss the formation of your LLC

OUTLINE

I.introduction

II.legal representation

III.general questions about the llc and the members

IV.basic LLC financial questions

V.events of dissociation of members; buy-outs of dissociated members

VI.admissions of new members; members’ sales of their membership rights to third parties

VII.llc management and operations

VIII.member meetings and votes

IX.member and manager fiduciary duties and liabilities

X.miscellaneous

Dear Clients:

I. introduction

In order to do a competent job in forming a multi-member LLC, it is necessary for an LLC’s founders (who will also generally be its initial members) to consider numerous factual, legal and tax questions, including some that are technical and thatoften will require a lawyer’s assistance to address properly. The most basic questions that LLC organizers should consider in planning to form multi-member LLCs are set forth below.

II. legal representation

Whom should I represent in forming the LLC? One of the members? Two more of the members in a “joint representation”? U.S. lawyers are subject to somewhat complex ethical restrictions with respect to joint representations.

III. general questions about the llc and the members

1)Name of LLC.

a)What should be the name of the LLC? Is this a good name from a marketing viewpoint?

b)Does Google indicate that any other company has such a name?

c)If the name will be used in a federal trademark or service mark, is the name available for that purpose?

2)Identity of LLC’s members. Who will be the members of the LLC? What are their full legal names and their residential addresses?

a)If the members have estate plans that include revocable trusts, they may want to consider holding their LLCs through these trusts.

b)They may want to consider making use of a transfer-on-death statute if available in the relevant states.

c)They may want to consider holding their memberships through joint tenancy.

3)LLC’s address. What will be the address of the LLC’s principal place of business?

4)LLC’s purpose. What will be the LLC’s principal purpose?

5)Date of formation of LLC, etc. On what date do the members want to form the LLC? On what date do they want to launch its business?

6)LLC’s registered agent and office. Which member or other person should serve as the LLC’s registered agent for Secretary of State purposes? What should be the address of the LLC’s registered office for these purposes?

7)LLC’s management structure. What should be the management structure of the LLC? Should all members participate equally in LLC management, or, instead, should LLC management be reserved to one or more managers?

a)If the LLC’s management is reserved to managers, who should be the managers?

b)The most common management structures for multi-member LLCs are these:

i)General partnership management structure (all members participate more or less equally in management decisions and in conduct of the LLC’s business and internal affairs);

ii)Simple limited partnership management structure—member-controlled (one or more members conduct LLC’s day-to-day business, but all members have a vote on significant LLC matters);

iii)Simple limited partnership management structure—manager-controlled (one or more members conduct LLC’s day-to-day business; non-manager members may vote only on a few narrowly-defined LLC matters (such as dissolutions));

iv)Corporate management structure (the classic corporate shareholder-director-officer-employee structure).

8)LLC dispute resolution. If there are disputes among the members about the LLC, should these disputes be resolved by mediation, in court or by arbitration? (It often makes sense to provide in the LLC’s operating agreement that disputes will be resolved first in mediation, but, if mediation fails, in arbitration.)

9)LLC’s federal income tax structure. For federal income tax purposes, should the LLC be a C corporation, an S corporation or a partnership taxable under Internal Revenue Code Subchapter K?

10)Social Security Taxes. Do the members want to structure the LLC so as to minimize their Social Security Taxes on their shares of LLC net income? (However, if they do so, this may reduce their Social Security retirement benefits and the amounts they can contribute to tax-favored retirement plans.)

11)State tax issues. What state and multi-state tax issues are significant for the LLC and its members?

12)Budget and business plan. Should the LLC have a written budget or business plan? Should the members expressly approve this plan? Should the members agree to update the plan on an annual or other basis?

13)Possibility of holding company/operating company structure. Should the business of the LLC be conducted through a holding company (which will hold the LLC’s valuable assets) and an operating company (which will conduct the LLC’s operations and lease, license or borrow these its assets from the holding company)?

IV. basic LLC financial questions

1)LLC’s initial need for cash, etc. How much cash, property, insurance and other resources will the LLC probably need in order to be adequately capitalized at the time of its launch? (An LLC is adequately capitalized if it has enough cash, cash flow, debt financing, insurance, non-cash property and other financial resources to cover its reasonably foreseeable obligations as they become due.)

2)Members’ contributions to LLC. What cash, property and services will each of the members contribute to the LLC in exchange for their membership rights? When will they make these contributions?

3)Benefits to be provided to the LLC by the members other than contributions. As a condition for obtaining their memberships, should any of the members be required to do anything besides making contributions to the LLC? E.g., should they be required to guarantee loans or to lease equipment or other property to the LLC?

4)Profit sharing. To what percentage of LLC profits will each member be entitled?

5)Distributions of profits. If the LLC has net profits, should it retain these profits to grow its business, or should it distribute some or all of them to the members?

a)If it should distribute them, when and in what amounts?

b)Should the LLC at least distribute to the members enough cash to cover their taxes on their shares of LLC profits?

V. events of dissociation of members; buy-outs of dissociated members

1)Events of dissociation; puts and calls.

a)Should members’ management rights in the LLC terminate upon the occurrence of the “events of dissociation” listed in the table below? (“Events of dissociation” are events, such as death or resignation, that terminate a member’s membership.)

b)Upon the occurrence of such an event to a member:

i)Should the LLC have a “call” right—i.e., the right to require the dissociated member to sell the member’s membership rights back to the LLC?

ii)Should the dissociated member have a “put” right—i.e., the right to require the LLC to buy out the member?

c)The table below may provide a useful tool for analyzing and decided the above questions.

EVENT OF DISSOCIATION / DOES DISSOCIATED MEMBER HAVE PUT RIGHT? YES/NO / DOES LLC HAVE CALL RIGHT? YES/NO

Death

Resignation with commitment not to compete

Resignation with no commitment not to compete

Disability

Bankruptcy

Divorce

Expulsion

Other (if applicable)

2)Expulsions. On what grounds should members be able to expel a member?

3)Buy-out prices, etc. What should be the price at which “puts” and “calls” must be exercised? What should be the installment terms, interest terms and other non-price terms of these buy-outs?

a)Should all of these various terms be determined:

i)By a formula established in the operating agreement;

ii)By an appraiser;

iii)By negotiation at the time of occurrence of the event of dissolution in question;

iv)By arbitration if, when the event of dissociation occurs, the members cannot agree on price and non-price terms?

4)Duration of options. What should be the duration of member and LLC put and call options? (A duration of one year is often appropriate; but the matter may depend on many variable facts.)

5)The “deadlock” issue in two-member and four-member LLCs.

a)Two-member LLCs. With any two-member LLC, a common problem is that of deadlock among the members on major LLC issues. These deadlocks are sometimes so serious that the members no longer want to operate the LLC together. In such a situation, an effective solution—although often a painful one—is a “Texas shoot-out provision.” Under such a provision, either member may propose to buy out the other for a specified price and specified non-price terms. The other member must either accept those terms or buy out the first member on the same terms. A Texas shoot-out provision can go far toward guaranteeing that the first member will offer a fair buy-out price, and it often preserves a going business that might otherwise have to be dissolved.

b)Four-member LLCs. Texas shoot-out provisions can also be useful in four-member LLCs whose members are both married couples.

VI. admissions of new members; members’ sales of their membership rights to third parties

1)Admissions of new members. What vote of the members should be required in order for the LLC to admit an additional member? Unanimous vote? Majority vote?

2)Members’ sales of their membership rights to other members and to third parties. What vote of the members should be required in order to approve a member’s selling the member’s membership rights to another person? Unanimous vote? Majority vote?

3)“Drag-along” and “tag-along” rights. If a third party offers to buy the membership rights of a majority of the members, should the minority members have:

a)A duty to sell their membership rights to the third party;

b)A right to block the sale unless the third party also buys the membership rights of the minority?

VII. llc management and operations

1)Identification of LLC functions. What are the main LLC business functions that must be handled by the members in order to for the LLC to succeed?

2)Member functional responsibilities. Which specific members or other persons should handle each of these functions?

3)Salaries and other compensation to be paid by LLC to members. Should the LLC pay a salary to any of the members? If so, how much? Should the LLC pay year-end or other bonuses to the members?

4)Fringe benefits to members. Should the LLC provide health insurance or other fringe benefits to any of the members?

5)Managers’ titles. What titles should managers use in dealing with third parties on behalf of the LLC?

6)Managers’ terms of office. Should managers serve as managers for a set term or for indefinite terms?

7)Manager removals. On what grounds should the members be able to remove a manager?

8)Signing of LLC contracts. Which members or managers should have the right to sign contracts on behalf of the LLC?

a)Should these members have to obtain the consent of other members in order to sign a contract if the contract amount exceeds a specified dollar amount?

9)Conduct of LLC business. Which members or members should have the right to conduct the business of the LLC—i.e., to deal with suppliers and customers?

VIII. member meetings and votes

1)Matters that only the members may decide. On which types of matters should the members as such be able to vote?

2)Matters that only the managers may decide. Which types of LLC matters should be reserved for decision by the managers?

3)Member voting power. How many votes should each member have on each member matter?

4)Voting requirements. How many member votes should be required to decide member matters?

5)Member meetings. Should the LLC hold annual or other meetings that the members must attend?

6)Minutes. Should a member or other person be required to keep written records of important decisions by the members and managers?

IX. member and manager fiduciary duties and liabilities

1)Duty of loyalty. Should the members and managers have a general duty of loyalty to the LLC—i.e., a duty, with regard to LLC matters, to put the interests of the LLC ahead of their own interests?

2)Duty of non-competition. Should the members and managers have a duty not to compete against the LLC:

a)While they are members;

b)Thereafter?

3)Duty of care. Should the members and managers have a duty of care toward the LLC?

4)Duty of candor. Should the members and managers have a duty of candor toward each other? In other words, in connection with the formation and operation of the LLC must each of the members take the initiative to disclose to the other members everything the member knows that may be relevant to the LLC?

5)Duty of confidentiality. Should the members and managers have a duty to maintain the confidentiality of confidential LLC information?

6)Liability for money damages. Should members and managers who breach any of the above fiduciary duties be liable to the other members for money damages?

X. miscellaneous

1)LLC’s accountant and lawyer. Who should be the LLC’s primary accountant and lawyer?

2)LLC dissolution.

a)Should the issue whether the LLC should be dissolved and liquidated be decided by vote of a majority of the members or by some other factor?

b)Should the operating agreement provide that the members waive any right they may have to seek judicial dissolution of the LLC if they become deadlocked or if there are other serious disputes among the members or if there is serious member or manager misconduct?

3)Number of arbitrators. Should any arbitration under the LLC agreement be decided by a single arbitrator or by three arbitrators?

4)Matters that the arbitrator may decide. Should the arbitrator be free to address and resolve LLC issues even if these issues are not addressed even indirectly in the LLC agreement?

C:\J2\Deskbook - Client initial contacts and initial meetings--checklists, etc. - 9-3-13i\MEMO TO CLIENTS WITH QUESTIONS RE MMLLC FORMATIONS - 3-18-14.doc