MYTHS AND REALITIES – STARTING OR JOINING AN LLC OR CORPORATION WITH FRIENDS, FAMILY MEMBERS AND ACQUAINTANCES.

As a lawyer who litigates disputes among partners, close corporation shareholders, and limited liability company members and managers, I hear a lot of myths about them.  The myths below are in italics, with my (sometimes snide) comments below each one.

I will be an owner, so of course, I will be employed by the Limited Liability Company.

Unless you have a strong employment agreement for a term of years (or until you die or retire) or employment is guaranteed in the Operating Agreement, there is nothing inherent in being a Member/Owner of an LLC that guarantees employment.  

An LLC Operating Agreement is a standard document that can be found on the internet.

That Operating Agreement that you found on the internet is worth every penny that you paid for it.  It may be even worth less than nothing.  An Operating Agreement that the parties do not understand and that is not specifically tailored to meet the needs and expectations of the members may have unintended consequences.  The provisions might work in your favor, but they might just as well work against you.

We hired a lawyer to set up the company, so she will look out for my interests.

Not necessarily. It is understandable to want to save costs when setting up a company and to jointly hire a lawyer to draft the Operating Agreement or By-Laws.  But that cost-savings comes with a price.  The lawyer cannot advocate for any one of the founders.  The minority owners are in particular need of protection, but the lawyer cannot advocate for the minority because she owes a duty to all the founders.  In a perfect world, everyone gets their own lawyer, but of course, this rarely happens.  If you are the minority owner or you are joining an existing company, at least consider having an independent lawyer review the Operating Agreement and suggest changes to protect you and your expectations in the company.

We are equal owners, so we must get paid the same salary and have equal say.

Nope.  The people running the business (President, CEO or Managers) will decide the compensation.  You could argue that the compensation is unreasonable, but you will have to prove it and you may have to file suit to do anything about it.

As for equal say, usually, the officers, managers or board of directors have all the say.  If you are not one of those, your opinion may count for very little.

At least my business partners won’t withhold dividends or engage in self-dealing.

But what if they do?  You need to guard against this as much as possible.  When it does happen, you have a few options: (1) a legal battle; (2) sell your interest to the majority at a discount; (3) go away with your tail between your legs.  

My business partners and I trust each other, so that’s enough.

Ha!  That one made me laugh.

Of course, you might be right that your business partners are good and decent people.  But even those rare birds will have legitimate disagreements. Documenting your expectations can help avoid this.

Also, think about what happens if your reasonable business partner dies and her crazy husband Larry inherits her ownership interest.  A buy-sell agreement with life insurance can address this, but it also shows why you need a strong operating agreement or shareholder agreement.

If I need to liquidate or if I can’t work with my partners, I can just sell my shares. 

Maybe you can in theory if there are no restrictions on transferability.  But if the environment is toxic, no one will want to buy your interest.  You need an exit strategy going in.  You need to foresee potential disputes and guard against them.

If my business partners try to screw me over, I’ll just call the LLC Police.

Okay, I made that one up.  The point is that no one is going to assist you in a private business dispute other than a lawyer that you hire on your dime.  You can’t expect the Attorney General or Secretary of State to get involved unless there is a public interest.  

If you have a clear case of embezzlement, maybe you can get law enforcement interested.  But these situations are usually not clear-cut and law enforcement sees them as civil matters.

My own father/son/mother/brother/sister won’t turn against me.

Maybe not your family member, but I’ve seen all of these unsavory situations in family businesses.  

At least I can’t be personally liable for corporate obligations or wrongs that I or the LLC commit.

This is partially true part of the time, but now always.  Clear? Here’s the thing, if you properly follow corporate procedures and record keeping, you may avoid contracts that you did not personally guaranty and wrongs that you were not involved in.  The reality is that the owners of most small businesses are involved in all actions and decisions.  Creditors, banks, landlords and others may insist that you personally guaranty company obligations.  So personal liability can be hard to avoid unless you are a larger, more established business.

As always, the above is not legal advice.

By Adam P. Whitney, Esq.

617.338.7000