In this lecture Kathryn McCall explains the practical steps and considerations for forming a Limited Liability Company (LLC). She begins with the mandatory filing of Articles of Organization with the Secretary of State, noting that most states require only this filing, while California and Delaware also require an operating agreement. McCall strongly recommends having an operating agreement regardless of state, as it defines ownership percentages, profit and loss distribution, decision‑making authority, management structure, and whether the LLC will be governed like a corporation or a partnership. She outlines the primary advantages of an LLC—limited personal liability for members, reduced record‑keeping compared to corporations, and high structural flexibility—but also warns that this flexibility can lead to complexity, especially when drafting detailed operating agreements that may span from a few pages to dozens. The discussion then shifts to disadvantages: LLCs do not issue stock, which can deter traditional startup investors; the flow‑through tax treatment can push members into higher personal tax brackets or create multi‑state tax exposure; investors may resist the pass‑through of profits and losses; and role ambiguity can arise among multiple members. McCall emphasizes the importance of coordinating the operating agreement with accountants and investors to avoid unintended tax consequences and to clearly delineate management roles. She also notes that LLC law varies by state and that, despite being a relatively new entity type (about 30 years old), it requires careful planning to balance its flexibility with operational simplicity.
Chapters
So these are the advantages and disadvantages of the partnership that we've discussed. So let's talk about forming an LLC. You file articles of organization with the Secretary of State. So this is the first time we've talked about with an entity where you're actually making a filing to a government entity about your organization. And for most states— That's all you have to do. Some states, California and Delaware being 2 of them, you have to have an operating agreement. Regardless of what state you form your LLC in, I really recommend you have an operating agreement. That operating agreement, similar to a partnership agreement, is going to determine how your profits and losses will be shared, how you're going to designate ownership percentages. Who owns what? I'm 35%, somebody else is 25%, somebody else is 5%. How are all those ownership percentages distributed? And it also gives you rules and regulations for smooth operating procedures. Who's going to make decisions? How are those decisions going to be made? Who's going to be the head? Who's going to be the managing partner? How are you going to set up— The structure. This LLC? Are you going to set it up similar to a corporation or similar to a partnership? How is all of that going to come into play? And that's all in your operating agreement. Now, advantages. Limited liability. So, again, members are protected from personal liability for debts, liabilities, and actions of the LLC. So, you get that protection. There's less recordkeeping in an LLC than in a corporation. There's flexibility. The LLC is insanely flexible. I get a little frustrated when I have clients come to me and they want to form an LLC because I could go on for days about how do you want to structure it, what do you want this to be, how do you want this to work, how do you want the taxes to work, is somebody going to get There— if everybody's putting money in, is somebody going to get their money first before other people get money? How is all of this going to work? Yes? And is that all figured out in the operating agreement? It's all set up in the operating agreement, yes. So sometimes— I mean, I have operating agreements that are 10 to 12 pages. I have operating agreements that are 75 pages. Yes? How do you write an operating agreement? You sit down first with your client. And try and get from them how they see the LLC working. How is it going to be governed? What are the voting— what's— is it going to be majority rules or are there certain decisions where you want decisions to be made by more than a majority? And then how do you want the profits and losses to be distributed? And then that's kind of the beginning stage and then it can build. From there. So, LLCs can be really simple or incredibly complex, which is— can be really frustrating at times because they're— it's one of those things that they're so flexible that you can get overwhelmed in how flexible it is. And then we can do this, we can do that, we can do this. And I'm like, wait, wait, wait. Like, let's get the operating agreement done so you guys can start focusing on building the business. I mean, I've spent months and months and months on an operating agreement. I have a company I'm working with right now. They're transitioning from being a corporation to an LLC. We started the process in January and we are not done yet because the operating agreement is not done. So, is it easier to go from LLC to corporation? I wouldn't say one is easier than the other. What the complexity with this one is trying to nail down— they've got different types of investors, so they're all taking profits or money out of the LLC at different stages. So then a lot of it is negotiating that on the side and then just trying to draft it. And then you get involved in— with LLCs. LLCs are driven a lot by tax. So then every time I draft something, then I run it by the accountants to make sure we haven't created any inadvertent negative tax implications. Or sometimes if we have, we at least want to make sure that the members who are affected understand what those negative tax implications are. So again, it can be really complex, which can make it— you know, people are like, oh, LLCs are so easy to form, easy to manage, but they can be really complex. And then, you said the flexibility can be a good and a bad thing. So then you've got the disadvantages. There's really no stock in an LLC. And so everybody talks about stock in startups. How much stock did you get? What are you getting for your stock? Are you going public? Are you going to sell your stock on the stock exchange? Members get percentage interests instead. So it's like I own 30%. I own 20%. Somebody else has 5%. You can designate what we call units. I have a Series A unit in an LLC. I have a Series B unit or something like that. But they're really not stock ownership that can be sold on an exchange or something like that. So, a lot of investors aren't really willing to invest in an LLC. The tax flexibility can backfire. You may not— if your LLC has a lot of profit and that's flowing through to your personal income tax return and shoving you into a different tax bracket. You may not like that. It may not necessarily be an advantage. Also, a lot of— if you're looking for outside investors, they don't— sometimes they don't want that flow-through. Like, I'm sorry, like, we don't want your profits and losses flowing through to our income tax. Our income taxes are complex enough. Like, we don't want that. Or it could be if they're in a different state, that might mean that now they're subject to taxes in your state where if they're in Illinois, They invest in you in California. Now they might be subject to income taxes in California, which they may not want. There can be confusion about roles. Like if you're all members, you know, like if you're— if you've got 5 members, who's the leader? Who's going to take control? My law partnership, I have 29 partners. We have 1 managing partner and we have an executive committee of 3. So, we know like these are decisions that the managing partner makes. These are decisions our executive committee makes. And then for the rest of it, we're just pretty much answerable to ourselves and then also to the partnership. And the laws can vary by state. And it's a relatively new type of entity. I mean, by new, I mean like 30-odd years. But that's pretty new when you think that corporations have been around for a couple hundred years.
