12 LLC Myths Debunked

Chrysler, the famous car manufacturing company, and MailChimp, a big name in email marketing services, have this in common. During the 1990s we’ve seen it explode in the US, and it’s still a heavy hitter, with famous tech startups — such as Grasshopper and Braintree — employing it. Yep, today, as the title suggests, we’re talking about limited liability companies (LLC), a business structure that’s known for its attractive “pass through” profits and losses as well as its limited liability advantage for members. But just what do we know about this relatively young American business entity? How much of it really is fact and how much is fiction? Test your knowledge with how much you really know about this business entity. (As a head’s up, #6 will change the way you conduct business name searches on the Hawaii secretary of state website.)

1. LLCs Can Go on Forever

Yes and no; this one depends on the state. In some states, an LLC dissolves when one of the members (equivalent to a corporation’s shareholders) is expelled, suffers from bankruptcy and/or a disability, dies, or withdraws from the company. In which case the LLC is no more, unlike a corporation which survives beyond its members — think Henry Ford originally incorporating Ford Motor Company in 1903.

2. An LLC Is Pretty Much a Partnership

Definite myth. While the business entity shares some similar features with a partnership — like pass-through taxation, which the IRS granted in 1988 — it is a solid and separate business entity. In fact, the main difference between an LLC and partnership boils down to the way the LLC is designed. Meaning that the LLC is designed so that company assets are separate from personal assets. This is why during a suit normally the LLC is on trial, not the members (although there are always exceptions).

3. LLCs Started in the United States

False. In fact, LLCs have been around in Western Europe for centuries. If you look at Germany’s equivalent business structure, Gesellschaft mit beschränkter Haftung (or “company with limited liability”), you’ll see that they’re very similar.

4. An LLC Is Doomed to Dissolve Eventually

Like #1, again yes and no. It’s a harder no though if there are specific instructions outlined in the operating agreement. However, the way LLCs form and dissolve depend on the state it’s enlisted in.

5. No Need to File with the Secretary of State

False… to an extent (which we’ll go more into detail later). Unlike sole proprietorships in some states, LLCs must go through some formal filing procedure, the most popular being this route.

6. An LLC’s Business Name Can Include Words Like “Bank” and “Insurance”

Depends. In some states, these (and others) are restricted words. For instance, Hawaii restricts bank, insurance, doctor, engineer… from being used in business names without the proper paperwork and permission. Nonetheless, words like FBI and IRS are forbidden in most if not all states simply because it would cause confusion.

7. You Must File with the Secretary of State

Again, depends. In some states, yes, you’re instructed to file with the secretary of state. Other states, however, require that LLCs are filed with sectors such as the State Corporation Commission, Department of Commerce and Consumer Affairs, Department of Consumer and Regulatory Affairs, or the Division of Corporations and Commercial Code.

8. You Must Create an Operating Agreement

Actually, in most states, you don’t have to. However, especially for multi-member LLCs, it’s recommended that you do, and here’s why. Think of the operating agreement as the instruction manual to a machine. It outlines financial and organization structure. It lists the rules and regulations. It instructs members about their rights and responsibilities. That and more. So, should the machine start to malfunction, you can check the manual to see what you need to do. The same applies to the operating agreement when a problem with the LLC or its members pops up.

9. Once the LLC Is Properly Filed, It’s Good to Go

Maybe. In some states, that’s a solid yes. But in others, like Arizona and New York, that’s a firm no. The reason being, business owners in New York and Arizona particularly, need to publish an official statement in the local newspaper announcing that the LLC is now in business. So, business owners, check on your state’s secretary of state website to see if this is required.

10. There Are Only Three Types of LLCs

Nope. Although single-member, partnership, and corporation are common LLC statuses, an LLC can have an S corporation status. Possibly even a nonprofit status.

11. LLCs Have Been Around in the US for Centuries

Myth. Try decades. This business structure actually first became official in 1977 in Wyoming. Wanting to attract capital and create a statute for a Texas oil company, the Cowboy State adopted the limited liability company business entity. It wasn’t until the 1990s, two years after the IRS announced LLCS would be taxed as partnerships, that this business entity took off in the US. Unlike Western Europe, which has used this structure for centuries.

12. Members Aren’t Liable

This is a shocker: not quite. Before you roll your eyes, let us explain. In a majority of cases, the liability lies with the LLC, not the individual members. (Something that you see with corporations, not with sole proprietorships and partnerships.) But — there’s a but — individual members become liable when they personally break a contractual obligation or commit a tort. In these instances, the court pierces the corporate veil, going after the members, not the LLC. Now, creditors can seize the members’ personal assets to pay off corporate debt. The court can try members for fraudulent activity. And, depending if government programs are involved — social security, unemployment… programs that deal with owners and employees, the court could go this route. Pierce-the-corporate-veil actions aren’t black and white; depending on the legislative goal, this could or could not be a possibility.

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