Forming a Limited Liability Company

LLC?I am starting a new Internet business in my spare time, and have considered forming a limited liability company (L.L.C.) for this business. I also owe a ton of money to some people, and there?s a good chance I may have to file personal bankruptcy in the next year to two years. I have heard that if an L.L.C. has only one member, it doesn’t really protect you because your 100 percent ownership interest in the L.L.C. becomes just another asset your creditors can attack. However, if you set up an L.L.C. with two or more owners, the L.L.C. will be considered an entity separate and apart from you so that any assets in the L.L.C will be safe from your personal creditors.

“I don’t want to share ownership of the LLC with any business partners just yet. So here’s my question: Can I set up an LLC, which I own and manage, but give an interest to another person who won’t have voting rights or a share in the LLC’s profits and losses, but merely the right to receive one-hundredth of one percent of whatever I get when I sell this LLC to someone else, as I probably will want to do if it is successful? Will that be enough to make this a ‘two person’ LLC legally?”

First of all, you will need to talk to a good bankruptcy lawyer. There are a number of rules that prohibit debtors (that’s you) from transferring assets to anyone — not just a company — for less than fair value if your intent is to harm or defraud creditors and/or there is no “bona fide” business reason for the transfer. These are called “fraudulent transfer” or “fraudulent conveyance” laws, and you will need to take them into account before you make any capital contributions to your new LLC. You may, for example, have to get an independent valuation of any assets (other than cash) you transfer to the company.

Having said that, there is a growing body of law in many (not all) states that an LLC with more than one member may be considered an entity separate from its owners if any of the owners is sued by personal creditors. I doubt, though, that what you are proposing here — setting up a “dummy” LLC member who doesn’t have any real power or authority — will pass muster in a court of law.

It is perfectly legal to give someone a percentage of the “net proceeds” (gross proceeds less transaction costs) of a future sale of a company as their sole compensation for services rendered to the company. Quite a few investment bankers and other “finders” who scout out acquisition partners for companies make good money this way. Whenever I have prepared a contract for such an arrangement, though, I always include a very clear statement that the individual is “not to be deemed or considered a member, partner, employee or agent” of the company for any legal purposes whatsoever.

Under most state laws, members of an LLC enjoy certain statutory rights. These include, among other things, the right to vote on matters requiring the members’ approval, the right to participate in managing the company’s business, the right to receive distributions of cash or property, the right to receive allocations of the company’s profits and losses, and the right to review the company’s books and records.

Most states allow you to deny some of these rights to certain members — for example, you can designate some of your members as “non-voting” — in your LLC operating agreement or by contract with individual members. I do not know of any state that would consider someone having only the right to participate in the proceeds of a company sale, without any of the other rights granted by law, to be a legal “member” of an LLC. You could, of course, state clearly in your LLC operating agreement that such a person is a “member” of the LLC, but if any of your personal creditors decides to challenge the arrangement as a “sham” with no legal substance, you are likely to be a “test case” and there’s no assurance a court will buy it.

So what can you do in a situation like this? If state law allows you to shield assets from creditors by forming an LLC with two or more members (this is not the case everywhere), you will need to be sure those members are “bona fide” business partners, not “dummies,” “straw people” or “paper members” who sign the LLC paperwork solely to help you satisfy a legal requirement. They will have to have at least some of the rights that state law grants to LLC members, particularly the right to share in the profits and losses of the LLC business. You probably also will have to give them more than a 0.0001 percent interest in order to satisfy your state law requirements.