Over the years we have counseled many businesses to become LLCs and S Corporations that operate on Cape Cod, southeastern Massachusetts and even nationwide. These clients come to us at one of roughly three different stages: 1) during the business start-up period, 2) when it is clear that the business is established and making a profit, or 3) when the business develops a problem. Many times, the third category of business had been operating without having formed an entity, or else having used online services like “Legal Zoom” or “Rocket Lawyer” to create their LLC or S Corp. documents. It is telling that these services emphasize the speed of their services, for many details are ignored in the process. This article describes the most common problems (i.e. lawsuits) we have dealt with because of these do-it-yourself and online LLC or company agreements.
1) The Essential Buy-Sell Agreement
This is probably the most frequent trap that a Cape Cod business attorney will see from improperly structured Massachusetts LLC operating agreements or sets of corporate by-laws. The buy-sell agreement outlines how a business is to transfer or wind down a business in the event that an owner wants to sell, goes bankrupt, or passes away. Many times these provisions are completely absent or do not take the specific aspects of a business into consideration at all.
Consider, for example, that two individuals agree to invest in a simple cash business like a car wash. Charles has managed car washes for years and already operates a successful one in an adjacent town. Mary, an accountant with an extra $50,000, would like to put this money to work for her and has always thought that Charles’ business was a great and simple one. The two get together and form their Massachusetts LLC on Legal Zoom. The online form asks them for specific information about the members, percentages of interest and management. Charles agrees that he will hire the staff of the car wash and will oversee the general operation, though he still has another car wash to manage.
A few months later, Mary becomes concerned that the business is not generating any profits, at least any that she has seen. When she calls a meeting with Charles, she discovers some alarming news. Charles not only hasn’t visited the car wash in a month, but has sold his own interest in the LLC to the “manager” he hired to run the day-to-day operations. He reasons that he was unable to adequately run two separate car washes at the same time. Now, Mary is in the unfortunate position not only of having an unprofitable business, but of having to resolve the issue with a partner she has never met. The LLC should have included a detailed buy-sell agreement requiring Mary’s sign-off regarding the sale of any part of the business. Even better, this same agreement might have enabled her to exit the business as soon as she found out Charles was not actually managing the business.
2) Limited Liability Traps for the Unwary
Another major flaw in the speed lawyer, online business formation industry is the need for the filing and annual review of company documents. While S Corporations require more formalities in Massachusetts, in our experience even the simplest LLCs neglect to file for years in a row. Such neglect effectively eliminates the company’s limited liability status altogether, thereby removing the reason the entity was formed in the first place! And in order to restore limited liability status, the business needs to file all of its omitted annual filings from years past — often for thousands of dollars. If the business does not, then when a lawsuit is brought against it, the owners themselves can often be held personally liable. Hiring an attorney at a firm like ours guarantees that these deadlines and formalities are met, curbing expenses and risks down the road. Using a one-time online company formation service, no matter how sweet the offer sounds, simply cannot provide this type of service.
The same legal relationship often yields further other unplanned-for advice concerning the conduct of an LLC to maintain its limited liability. It is the kind of advice that can’t be offered without consistent one-on-one contact during the start-up process. We needed to inform one of our veterinarian clients, as an example, to correct its website and advertisements so that the letters LLC were displayed. Without the advice, the business owner was subject to personal liability.
3) Business Management Roles and the Control vs. Ownership Debacle
Sitting down with an actual person to draft LLC and S Corporation documents, as opposed to with a computer, can also identify other potential issues in the case where the business has more than one owner. Experienced business law attorneys have all seen the wrong side of business agreements, where two, three or four individuals start an enterprise without having clearly defined their own roles. At some point in the operations, one or more parties inevitably feel he, she or they are doing the lion’s share of the work. Anyone who has had a roommate or a spouse can understand this feeling.
But unlike cohabitation, partnership often involves a significant investment of time, money or both, not to mention the main source of one’s income. And so while a roommate contract or prenuptial agreement might seem like overkill in many relationships, a concise and well thought-out partnership agreement is absolutely essential. That agreement should not only describe how each partner is expected to participate, but also how his failure to do so may result in the cut or sale of his shares or profits. An attorney familiar with such pitfalls is an invaluable resource in guiding these discussions.
4) Titling Assets & Signing Leases
After an agreement is formed, certain assets should be titled under the umbrella of a Massachusetts business owner’s LLC or S Corporation. And while the principles behind this might appear to be common sense, many intelligent individuals nevertheless make critical mistakes in the process. Again, an online service simply could not assess the intentions of its customers.
An individual chimney sweep owner, for example, would undoubtedly know to title her heavy duty chimney sweeping equipment and trucks in the name of her LLC, but she might not know what not to put in it. Many business owners think that it is advantageous, perhaps for tax purposes, to place their boats or family vehicles under ownership of the company. Most of the time, however, there are actually no tax benefits at all. Still, if the boat falls off its trailer and hits a vehicle, or if a teenage son gets into an accident, the LLC’s assets would nevertheless be on the hook.
5) Legal Issues & Service of Process
Following a do-it-yourself philosophy when forming a company, rather than consulting an attorney, also sacrifices other protections and benefits. Many of our clients use us as the “resident agent” of the Massachusetts LLC or S. Corporation. Doing so correctly can serve two purposes for a company 1) It allows us to contact state and private organizations on the company’s behalf when the client needs to conduct sensitive communications (for example on a regulatory or legal matter), and 2) It provides the company with a buffer from legal matters, ensuring that the client will not respond to legal or regulatory communications without legal counsel. In fact, the company can be registered in a way that all service of process from foreign parties can be routed directly to the attorney.
An On-call Resource for Your Cape Cod & Massachusetts Business
Proactive business owners understand that building a relationship with an attorney means having the benefit of legal knowledge whenever it is needed, not just at the beginning. And if a business is large or sensitive enough to require a limited liability entity, then it also deserves the protection of an on-call attorney that focuses his practice on building and structuring businesses. There are simply too many obstacles, and too many pitfalls that await an uninformed or unprepared business owner, to justify risking the life or health of the company. Taking the time to speak with one of our Massachusetts attorneys specializing in business before legal issues arise should be a clear priority for serious business owners.