Austin Lawyer Tip: Five Problems with Form LLC Formation

Many have asked the question, "why go to a lawyer when there is LegalZoom.com?" Well, for some sophisticated business persons with experience in corporate formation, it may be OK. But I have to say, having litigated a lot of disputes between co-owners of a business, LegalZoom.com is NOT a substitute for a lawyer (LegalZoom even admits this openly), and it is very often a pennywise and a pound foolish, emphasis on the foolish.

Now, I know many of you reading this may say, "of course, this is coming from a lawyer". True, I admit to some level of bias on this issue, but being biased doesn't mean I'm wrong.

Five Issues not typically dealt with in Form LLC Agreements

1. The problem of "OK, it's formed, I'm done"
There are many issues not usually dealt with in typical "form" LLC Agreements, but the worst thing is that most signers of LLC formation documents think that when the LLC is formed, everything is done. This is not true. There are so many other issues that need to be dealt with, including election of officers, delegation of duties, initial organization meeting, and many other discussions that need to take place. Now, the reality is that in single member LLC's, the member can do roughly whatever they please with the operation agreement at almost any time, but in two or multi-member LLC's, this is not the case. Think about how much easier it is to deal with issues such as one owner's death, divorce or bankruptcy than before said death, divorce or bankruptcy. Most form LLC agreements, particularly if only the certificate of formation is filed, do not adequately deal with these contingencies, or are not even reviewed by the members before signing the LLC agreement. Wouldn't you want to know whether you're going to be future business partners/co-owners with your business partner's husband or wife if they die? Wouldn't it be nice to know that a bankruptcy trustee will not hold the keys to whether your business can raise future capital? Yeah, I thought so.

2. The problem with the 50-50 ownership LLC
Split ownership sounds good..."hey we'll be partners!"...but in reality, what it means is that no one is really in control and it is management by committee. A properly drafted LLC agreement is a negotiation, and requires that the parties have dispute resolution built into their agreement, either through some sort of buy-sell agreement or arbitration/tie breakers. Nothing worse than a thriving business that is deadlocked on raising capital or operation directives. But Form LLC's are FILLED with them. And I don't get angry when I see them after disputes, I charge hourly to fight over them. But it is sad that this is almost always entirely avoidable with some element of design in the formation documents.


3. The problem with the money in the future
This is a constant problem in litigation with the "form LLC filers". At the beginning, everyone's happy. "Hey, Jimmie Joe, let's open a restaurant called JJSeras! It will be kicks!" "Sure thing, Sera Jean! Let's go halfsies!" All is fine and good. Until one of two things happens...(1)the restaurant does really well and there are disputes over speed of expansion and distribution (when one party stops working at the store), or (2) it totally does horribly and creditors are knocking on the LLC door. Well, if it goes bad, JJ and Sera are covered, right? Yeah, well, not if they had to personally guarantee the lease or credit facilities. And if JJ paid it all, but only owns 50% of the business still, how good does that make JJ feel? A properly done agreement deals with these issues before the dispute arises.

4. The problem with no exit strategy
Most people enter into LLC's with others without really thinking about how they will extricate themselves from it. How will one party buy out the other? How will it be valued? Very frequently form LLC agreements just don't deal with these issues, or are so basic that they really aren't designed for the parties involved and end up being useless. How about deciding on a person to do the valuation? How about agreeing to a system of valuators if there's no agreement? How about a buy-sell agreement?

5. The problem with majority rule
Many people who put investment money into an endeavor are not the ones running the show. Typically, those "money only" guys are doing this as an investment and gambling that JJ and Sera discussed above are going to give them a return on that investment, and are thus willing to be passive investors in the endeavor at a smaller percentage of interest. This makes the problem of the minority interest holder. I'm constantly amazed at people who put in thousands of dollars, get a minority stake, and when you look at the operating agreement, their interests are almost totally worthless because they can be practically eliminated by "majority rule". It sounds great on paper...but if you are a 10% holder, and the other guy owns 90%, and he can decide to dilute shares by "majority rule", well you're in for a heap of hurt.

It just makes sense to have attorneys review these documents. Typically it is not that expensive, and it just makes sense to have someone with experience reviewing those documents. Obviously, if you need assistance in a review, feel free to contact me at (512) 472-2300.

Marc Lippincott