Limited Liability Companies: Steps and Decisions in Formation
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The Limited Liability Company (LLC) has likely become – in North Carolina and elsewhere – the preferred entity of choice for most closely-held businesses, including farm operations. The LLC has also become more widely used to hold family land interests to separate such assets from farm operating liabilities and provide for orderly succession of ownership in the land assets. The LLC is a hybrid of a partnership (informality of management) and a corporation (limited liability), and has grown in popularity in modern legal practice.1 Formation, management and dissolution of LLCs is governed by the North Carolina Limited Liability Company Act (the “Act”)2 unless otherwise agreed between the owners by written Operating Agreement.
The North Carolina Limited Liability Act authorizes the formation and provides the framework for interest owner rights and entity governance in the absence of a written Operating Agreement between the interest owners. LLC’s provide essentially the same liability protections as the corporate form of business organization, but without the necessity of securing state permission to authorize shares in the company, or requiring a shareholder election of board of directors to elect officers to run the company. The LLC cuts through these requirements by simply allowing the founders to organize the company, secure its recognition from the state, then as an internal matter decide who will own what percentage and who will manage the company. Below are the decision and action steps in formation of an LLC.
Step 1: Who Are the Owners?
Owners of an LLC are generally referred to as “Members.” Members are normally those who come together to form the LLC and make its initial capital contributions (in the form of cash and hard assets).3 The Members’ relative contributions normally determine their percentage ownership, though other factors such as skill and intellectual capital may determine Member percentages. Like a corporation, a Member’s liability for debts of the LLC is limited to the liquidated value of his or her ownership interest the LLC.4 Ownership in the LLC is considered a percentage interest rather than distinct shares (as with a corporation), although many people authorize (by Operating Agreement) a number of “units” to represent the economic ownership percentage as a matter of convenience.
Step 2: Who Makes Decisions?
The person (or persons) authorized to make binding decisions and obligations on behalf of the LLC is known as a “Manager.” Under the Act, all Members are deemed to be Managers unless otherwise agreed in a written Operating Agreement executed by all Members.5 The Members can choose to designate one or more Managers to make operational decisions for the entity within limits specified in the Operating Agreement, reserving to themselves a vote in big decisions such as admitting new Members, making large purchases and financial commitments, and dissolution of the entity and distribution of assets. Traditional offices of President, Vice-President, etc. may be assigned as well.
Step 3: Determine Need for and Scope of an Operating Agreement
The decision to appoint from the Members a lesser number of Managers is of itself a reason to adopt an Operating Agreement.6 As noted earlier, in the absence of an operating agreement, the key elements of LLC management, governance and dissolution are governed by state statute. The operating agreement can address any number of issues, such as division of profits between members, the limits of management authority without a vote of the members, and restrictions on who can become members as well as restrictions on transfers of ownership. For example, an Operating Agreement may allow a Manager to make financial commitments up to $50,000, above which a percentage vote of Members is required to approve the transaction. Another key feature of an Operating Agreement can be a buy-sell agreement embedded within. Again, an Operating Agreement is not required to form an LLC, but depending on the relationships between the would-be Members, they may want to agree on the parameters of working together before filing.
Step 4: Choosing a Name
The LLC name must be distinguishable from all other entities formed or domesticated as LLCs with North Carolina Secretary of State (NCSOS).7 The LLC name can be identical to the business’s commercial name (what customers see on the sign) or it can be some other unique name if the commercial name is unavailable. If the commercial name will be different than the filed entity name, then the LLC organizer can complete and record an Assumed Name Certificate using the commercial name in the county register of deeds ($26 recording fee) where the principal office is located.9 This recording allows the business to safely use the chosen presented to the public and potential customers. If the commercial name has been trademarked under federal law or state law by another business, it is not available for use.
Step 5: Filing the Entity
The LLC is formed as a legal entity by filing the Articles of Organization with the NCSOS. It is easiest to use the form provided by NCSOS on their website.10 It is here that the founder or designee will take on the role of “Organizer” of the LLC to file the form. The form is fairly self-explanatory, includes instructions, and requires the following decisions:
LLC Name. As explained above, the name must be unique from all others filed with NCSOS. It may be that the first choice name was used by a now-dissolved LLC, and if sufficient time has lapsed, the name may now be available. The name must contain “LLC” or some variation thereof. If the name is registered as another entity type (e.g. corp.), the name is available for use as an LLC.
Party Filing the LLC. This is the name and address of the initial Member(s) or designated Organizer (e.g. an attorney) filing the Articles of Organization on the Members’ behalf.
Registered Agent. The organizer must designate a registered agent (usually a Member) with an address in North Carolina. The purpose of the registered agent is recipient for all official communications regarding the entity, including legal actions.
Principal Address. This address may be the same as the registered address but need not be. A principal office is not required, but doing so can help ensure that your county serves as venue in any litigation against the LLC.
Purpose of Entity. Optional, but for entities holding land enrolled in the Present Use Value, it is important to use the words “farming” or “forestry” in the organization’s purpose. For example, a purpose may simply state “The purpose of [this LLC] is to operate a farm and perform all business related thereto.”
Officers. Optional as well, the organizer may wish to list a President and other officers for the purpose of transacting initial tasks such as opening bank accounts, retitling vehicles at Department of Motor Vehicles, etc.
Signing. The parties listed as Member or Organizer (or both) on the LLC form must all sign the document. Unlisted Members need not sign, but if a Member will be transacting business on behalf of the LLC, it is advisable such Member be listed and sign as proof to third parties of said Member’s authority. An attorney may sign and submit the form as Organizer without individual Members’ signatures.
Submission. The organizer submits the signed form with a $125 check, or files online for an extra two dollars after establishing an account with NCSOS. Turn around is not immediate, but NCSOS offers an expedite fee of $100 for one day turn-around. Supplying an email on the Articles form helps more immediate address of deficiencies in the filing.
Step 6: Secure Federal Tax ID Number (Employer Identification Number or EIN).
Because the LLC is a distinct legal entity, it must have its tax own identification number. This is an easy online process with the Internal Revenue Service, the multiple information requests are accompanied by explanations, and the process takes about five minutes. Tip: At the conclusion when asked how you want to receive your EIN, request “receive EIN letter online” and you will get a download PDF of the IRS letter with your EIN.
Step 7: Open a Bank Account and Set Up Accounting.
With the EIN letter and the NCSOS acceptance certificate (showing your name as Member or other office), you may open a bank account. One of the primary liability limitation requirements of an LLC is that business and personal funds are kept separate. Upon opening the bank account, open a new company book in Quickbooks (or other bookkeeping software) for the new LLC.
Step 8: Retitle Vehicles and Update Vendor/Customer Contracts.
Titled vehicles contributed as assets to the LLC must be retitled at the Division of Motor Vehicles (DMV). Presentation of authority to transact is required. DMV charges a fee for each title change. Likewise, business contracts and FSA payee designations should be updated. If the LLC is to hold land enrolled in Present Use Value, application for continued use (AV-4) must be filed within 60 days of recording the deed of transfer. Tip: Though it may be enrolled in PUV, make sure the land qualifies in PUV before transferring title.
Step 9: Assemble an Organization Book.
While the only requirement of having an LLC is acceptance by the NCSOS, it is useful to have an organization book, such as a binder with tabs, holding the following documents:
- Articles of Organization (certificate from NCSOS)
- Operating Agreement (signed by all Members)
- EIN Letter (and any future tax elections)
- Ledger of Ownership Interests
- Unit Ownership Certificates (optional, but useful for executing transfers of interest to other Members)
- Asset List (e.g. equipment, other personal property contributed to LLC)
- Leases and contracts
- Annual Reports to NCSOS (this is annual requirement with $200 fee)
- Minutes of Member meetings
Step 10: Maintain the LLC.
As noted earlier, the LLC limits a Member’s liability to the extent of their investment in the LLC (ultimately reflected as the liquidated value of their economic interest). That said, it is always a possibility that a judgement creditor can persuade a court to disregard the LLC’s liability protections. Called “piercing the corporate veil,” the claimant with sufficient evidence might show that the entity was simply an “alter ego” of its owners, and not distinct from their personal affairs. To minimize this risk, it is important to keep LLC expenses and personal expenses separate (no matter how convenient or tempting to treat every expenditure as business) and keeping minutes of meetings. Required Annual Reports (a simple online process) are due April 15 of the year following the year of formation (with a fee of $200), and failure to file by the fall of that year will result in “administrative dissolution.” If your LLC is administratively dissolved, NCSOS will hold it as inactive for a specified time (before releasing the name) wherein you may pay a $100 penalty (and back filing fees) for reinstatement.
1 Schwidetzky, Walter D., The Pros and Cons of LLCs, Journal of Accountancy (December 1, 2018). Available at https://www.journalofaccountancy.com/issues/2018/dec/llc-pros-and-cons.html
2 N.C.G.S. Chapter 57D
3 N.C.G.S. §57D-3-01
4 N.C.G.S. §57D-3-30
5 See N.C.G.S. §57D-3-20 through §57D-3-23
6 See N.C.G.S. §57D-2-30 through §57D-2-32
7 N.C.G.S. §55D-21(b)
8 See N.C.G.S. §66-71.1 et seq.
9 N.C.G.S. §66-71.4
10 § 57D-1-21