- Hi everyone, I'm attorney Aiden Durham
with 180 Law Co. in Denver, Colorado.
And you're watching All Up In Yo' Business.
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In this episode of All Up In Yo' Business,
I'm gonna talk about some of the really common mistakes
that single-member LLCs make, and ways to avoid them
in order to protect your personal liability.
But before we get into it,
please be sure to like, subscribe and share
and check the description
for some additional information and resources too.
All right, so single-member LLCs.
Before we get into the big-time mistakes and risks
with single-member LLCs, a little background.
So what is an LLC?
An LLC is a limited liability company.
That's what LLC stands for.
The owners of the LLC are called members.
Therefore, a single-member LLC
is a limited liability company
that only has one member or one owner.
The purpose behind an LLC,
the general reason that we use LLCs to operate businesses,
is for limited liability protection.
That L-L in LLC is limited liability.
And what that means is that the liability
is limited to just the business,
rather than it being the liability
of the members or the owners themselves.
So by creating an LLC,
the single member has in essence created this new being,
this new legally recognized being
separate from him or herself.
Separate from the owner.
And the idea is that any liabilities, any debts,
any lawsuits, any legal issues that come up with the LLC,
are the legal issues of the LLC itself
and not the individual member.
So if there is a lawsuit or some kind of issue
and the LLC has to pay damages, let's say a million bucks,
it's the LLCs assets, generally speaking,
that are gonna be subject to that liability,
versus the members' individual personal assets,
like their home or their personal checking accounts
or personal investments.
The idea is that those assets,
the personal assets of the member,
will be protected from liability of the LLC.
Now I say that's the purpose and that's the idea behind it
because that's what we're aiming for.
But it doesn't always work out perfectly.
There are instances where a member
of a limited liability company
can be personally responsible,
can be held personally liable
for the liabilities or the debts of the LLC.
And this term generally
is referred to as piercing the corporate veil.
You want to imagine there's a veil of protection,
a protective cloak if you will,
a nice, warm, comfy blanket that the LLC gives you.
And it's this nice protective veil.
But if you do things wrong or if you make a few mistakes,
a court might decide to pierce that veil
and rip away your warm, comfy blanket.
And now you are fully exposed
and you personally are liable and responsible
for the debts of your LLC
and the liabilities and all the obligations of that LLC.
So even though the goal and the idea is to keep
that protective limited liability blanky around you,
that's the goal, but sometimes it doesn't work out that way.
And that risk of piercing the corporate veil
is much higher in a single-member LLC
as it is compared to a multi-member LLC,
where there are multiple owners.
Because it's just one member, one owner,
there isn't that checks and balances
that you would have otherwise with multiple members.
There aren't other varying opinions.
There aren't other people
that you have to check with or okay things with.
The single member has pretty much full authority
to do whatever she wants with the LLC.
And so that, in itself, makes it a little bit riskier
and increases the chances of piercing the corporate veil
because there's less of a separation
between the single member and the LLC
compared to a multi-member LLC.
Now when we talk about piercing the corporate veil,
there are a lot of different factors and details
that go into whether or not a court will decide
to pierce the corporate veil.
Now in Colorado, our law regarding this
is it's not necessarily going to be the same in every state.
Every state, every jurisdiction,
their laws with regard to under what circumstances
we will pierce the corporate veil,
those are gonna be a little different.
But I'll tell you in Colorado at least,
from our most recent court decisions and stuff,
the bulk of piercing the corporate veil
comes down to this alter ego doctrine.
Essentially the question is,
is this LLC merely an alter ego of its owner,
rather than being an actual separate entity?
And there are eight factors
that are gonna go into this alter ego question,
or eight factors that the court's going to consider
in determining if the alter ego does apply.
The first factor is whether the LLC operates
as a distinct business entity.
The second is whether funds are co-mingled.
The third is whether
adequate corporate records are maintained.
The fourth factor is whether the nature and form
of the entity's ownership facilitate mixed use by the owner.
Number five, whether the business is thinly capitalized.
Number six, whether the entity was used as a mere shell.
Number seven, whether shareholders
disregarded legal formalities.
And number eight, whether funds or assets of the business
were used for non-business purposes.
So those are the eight factors that a Colorado court
will look at when considering if an alter ego exists
and if they should pierce the corporate veil.
Again, every state,
every jurisdiction's gonna be a little different.
As far as I know, the general idea amongst all the states
is typically, it's pretty much the same.
It is kind of all based around this idea
of alter ego or whether there is a genuine separateness
between the owner and the company.
In Colorado as well, the whole alter ego thing by itself
typically isn't enough.
There also has to be some kind of showing of fraud
or misconduct or some other kind of wrongdoing with the LLC.
So it's typically not enough
just that those alter egos factors apply,
but there also has to be some kind of wrongdoing
on the part of the business owner.
But again, that all differs and will be a little different
for each jurisdiction and each area.
But like I said, generally the idea is pretty much the same.
So what kinds of things can we do to avoid those risks?
And what are some of the mistakes
that single-member LLCs typically make
that put them at risk?
Number one, obviously the big thing is separateness
of assets and funds of the business.
So, a big mistake that a lot of single-member LLCs make
is not having a separate dedicated business account.
Business checking account, business credit card accounts.
Every money that comes into the LLC is the LLCs money
and it needs to be held separately
from the individual member's money.
And so that is probably number one the biggest mistake
that I see is co-mingling assets
between the member and the LLC.
Whether it is holding all the assets in one account,
personal and business,
or if it's using business funds
to pay for your personal expenses.
So if you're paying your rent or your cell phone bill
or your Netflix subscription bill
out of your business account, that's bad.
That's co-mingling funds.
And that can get you in some hot water.
Aside from co-mingling funds or not keeping assets separate,
the second real big mistake
that I see a lot of single-member LLCs making
is not following corporate formalities.
Or not following these formalities
that we should be following.
With a single-member LLC, it seems weird
to do some of the things that we should be doing.
The best way to go about doing this
is to pretend you're in a multi-member LLC.
Or pretend your business is a corporation
and do what would be required.
(dog barking)
And do the things that you would be required
or normally expected to do
in a corporation or a multi-member LLC.
So when we're talking corporations versus LLCs,
the reason that LLCs are as popular as they are
is because LLCs have a lot of flexibility.
Generally, most states give LLCs a lot of freedom
to operate and form how they want to,
where corporations have a lot of requirements.
So for most states, corporations are required
to have bylaws or they're required to have annual meetings
or organizational meetings.
And they're required to do these certain things,
whereas LLCs are typically permitted to do those things.
So where a corporation might have to have bylaws,
an LLC may have an operating agreement.
An operating agreement for an LLC
is kinda the internal governing document
that talks about how the LLC is operated,
what its purpose is,
what the rights and obligations of the members are,
how decisions are made and how votes are calculated.
All of that.
So it would seem weird for a single-member LLC
to have an operating agreement.
'Cause, I mean, I'm the only one.
I'm the only one making decisions.
I'm the only person involved.
Why would I have to have an agreement with myself?
Well, you don't have to.
The states don't require it.
But we know from legal history and legal case precedent,
that it's still a really good idea
to follow those corporate formalities
even if it's not required
or even if it seems silly to do so.
So in a multi-member LLC,
we would have an operating agreement.
So you should have an operating agreement
for your single-member LLC.
A corporation or a multi-member LLC
might require annual meetings
or might require some annual meeting minutes.
Just because it's just you doesn't mean
you shouldn't have minutes or meetings with yourself.
Now, again, it seems pretty silly
to have a meeting with yourself.
And yeah, it kind of is.
But that's essentially what you wanna do anyway.
You know, you don't have to have an actual meeting.
What I typically recommend for my clients
is having a consent to action or some kind of written action
in lieu of actual, formal meetings.
And if y'all are interested,
check the description because I have linked
to a free download of a sample single-member LLC
consent to action for you all to use.
'Cause I've gotten a lot of questions on this topic
of what do our meeting minutes need to look like.
Like how do we document this?
And it's really a simple process.
So check the description
if you wanna download that sample template
for a consent to action for a single-member LLC.
Along with following those corporate formalities,
another important thing to do and another thing,
a mistake, that I see happening a lot
is under-capitalizing the LLC.
In other words, not keeping enough money in the LLC.
There is a thought, if you think far enough ahead
of this limited liability idea
of the LLC is the one
that's gonna be subject to liabilities.
It's gonna be the LLC's assets,
the LLC's bank accounts, the LLC's equipment.
All of that is what's subject to it.
So in theory, if I keep all of the money out of the LLC,
then I should be safe, right?
If 10,000 bucks come in to the LLC,
I need to pay that to myself
so that there's no money for the LLC to lose if it is sued.
Eh, you can't really do that.
You have to keep some adequate capitalization in your LLC,
in your business's account.
You can't deplete all of the assets of the LLC
solely for the purpose of avoiding liability.
So what does adequate capitalization look like?
There is no like bright line or hard rule about it.
Generally you wanna have enough in your LLC
to pay your expected overhead,
pay any debts or obligations that you know are coming up.
You know, just be a reasonable business operator
and keep enough in your business to continue operating it.
That's really all you need to do.
If your business isn't making a lot of money,
that's not going to be a huge negative effect.
Just because you're not making any money,
that doesn't mean you're under-capitalized.
There needs to be some kind
of a intentional under-capitalization really.
Another big mistake that I see
a lot of single-member LLCs make
is not properly representing themselves
under their capacity as a member of the LLC.
So what do I mean by this?
When we are signing contracts
or entering into any kind agreement with somebody,
we wanna make sure that it is the LLC
that is signing that contract.
It's the LLC that's agreeing to that agreement
and not us ourselves.
And so how we do that is we need to sign
on behalf of the LLC.
Because if you are undertaking an obligation,
if you're entering into a contract,
and you just sign your name
like you would any other contract,
you are agreeing to that.
You personally are signing that contract.
So you personally are bound by that contract.
And we don't want that.
We want the LLC to be the party to that contract.
So typically how this would look
just on a general kind of agreement or contract,
where the signature line is, it would have LLC's full name,
which that part's important, including the LLC portion
or if you put limited or LLC or limited liability company
at the end of your business name,
that part needs to be included in it.
So the signature line would have the business name,
by, B-Y, and then the member's name and the title,
which would be member.
So I would sign a contract 180 Law Co., LLC
by Aiden Durham, member, or Aiden Durham, president, owner.
The title doesn't particularly matter.
But what's important is that it's clear
that I am signing in my capacity as the member of this LLC,
and not myself, individually.
And then finally, a big mistake that I see
from a lot of single-member LLCs
is failure to get insurance coverage.
The LLC is a really great way
of protecting yourself individually
and protecting your personal liability.
But that doesn't mean that's the only way
of protecting your liability.
I think even more important than an LLC
is just general liability insurance.
Now what's the difference?
This is a really common question.
Like why would I need insurance if I have an LLC?
You gotta, they play two very different roles.
So let's say you have a general liability policy
of $1 million.
That's your limit.
Your coverage on the policy is $1 million.
If your business is sued and you are found liable,
your LLC has to pay $1 million in damages,
the insurance coverage is going to pay out those damages.
So nothing actually has to come out
of your company's pocket.
It's being paid by the insurance coverage,
by the insurance.
That's what it's there for.
Now let's say you're sued for $2 million.
Your insurance is only covering a million of that.
So whoever's suing you,
they still want that additional million.
And that's where they might try to go after you personally.
If, let's say, you've got a big house
or you are in a position where people think you're rich,
they're gonna try to go after you personally
for that additional million.
And that's where the LLC comes into play
to avoid that from happening.
So really when it comes to avoiding risks
of the single-member LLC and protecting your liability,
the big idea is that separateness
and following those corporate formalities
that you otherwise would if you were in a corporation
or a multi-member LLC.
That's all for this episode, folks.
Drop a comment below and let me know what you think.
And again, don't forget to check the description
for my free downloadable template
for a single-member LLC consent to action.
Thank you all so much for watching.
I'm Aiden Durham, and I'll see ya next time.
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