Kevin Johnson: Welcome to this presentation on Counseling the LLC client by Quimbee. My name is Kevin Johnson. This presentation includes a number of course materials, including today's slides, complete with detailed presenter notes. You can follow along with those slides or just relax and enjoy listening to these recommendations on counseling clients as they create and operate their business as a limited liability company.
State statutes describing how to organize and operate an LLC are the same, whether the business owner is a novice or experienced. State statutes do not describe significantly different procedures based on whether it is a brand new business or a business that has been operating successfully for a long time and its owners now have decided to organize it as an LLC. LLC legal issues are fairly constant and consistent regardless of the specific circumstances of a particular business or its owners.
However, people who want to organize and operate their business as an LLC can be wildly different from each other. How much experience do they have in business and what kind of experience do they have? How much do they really know and understand about the LLC entity form? Are they dreamers or are they practical? Are they focused on details or on the big picture? Are they comfortable working with a budget and finance, or not so much? Are they able to work well with others or are they better off left alone in the back room? Can they accept reality or are they always redefining reality? Or do they have a good balance of these and other issues relevant to operating a business? This presentation is not about how to comply with state law in order to organize a business as an LLC, and to then operate that business as an LLC, instead, the purpose of this presentation is to offer ideas and suggestions on how to effectively counsel people who come to your office to create and operate their business as an LLC.
Introduction. It is my intent that the content in this presentation applies equally well, whether the business owners you are working with are setting up their first business or are seasoned entrepreneurs. However, it may have a bit more relevance for those with limited experience. Entrepreneurs are rightfully so much more interested in and excited about their business than about the statutory details that apply when creating and operating a new LLC. After all, that's why they hire you. It's a lawyer's job to make sure there is compliance with all those legal things. And of course that is our job. But assuring legal compliance is more than just following statutory procedures.
As a start, those people in your office need to understand the identity of your client. Most likely it is the LLC that is the client, not its owners. This is a significant point for them and for the lawyer to understand. People should also understand that owning a business together is a type of close relationship, it is not a relationship to be entered lightly. Their only interaction with each other may be to operate their business, but they will be sharing what they have and what they hope to earn in revenues as well as the good days and the horrible days that come running a business. They'll be dependent on each other in some significant ways and they need to understand this and decide as much as possible that they can do these things together. I believe it is much better for our LLC client if it's owners operators understand the nature of their relationship with each other. As lawyers we can and address these issues on behalf of our client.
This presentation is divided into several sections, beginning with issues that are important before the LLC is created. Preparation of the operating agreement is addressed as this can be a great test for determining how well the owners share the same vision for their business. The corporate veil must be clearly understood in order to preserve the integrity and even the existence of the LLC. There are other issues, including disagreements, owners coming and going, succession planning, and whether, and when to close the business. Counseling the LLC client is about taking care of the LLC as its attorney. This will requires that we make sure the owner operators of our client fully appreciate what it means in day-to-day activities to be in compliance with the law.
Initial considerations. There should be a discussion at the beginning of the first meeting to determine whether your client is or will be the LLC or an owner, particularly if it is to be an LLC with one owner. My suggestion is that the LLC be the client. It is then necessary to explain what it means that the LLC is the client. It will also be necessary to explain the formal process required by state law to create the LLC and to then operate the business as an LLC. I have always enjoyed working with people who want to set up their own business. They tend to be optimistic, self confident, willing to accept responsibility, and energetic, even if they have some worries. If you are working with one person who will be the sole owner of the LLC, your job is a lot easier. The comments in this section are perhaps more applicable when two or more people will own the LLC, although they have relevance with a sole owner.
An important question is what do these people want to accomplish? I always ask people to describe their business idea. It may not take much of a description to state that they want to operate an accounting office, but it can matter whether they each describe handling the same type of accounting clients, or if they disagree on that, or if they are unsure exactly what their business idea will look like. The point is not what their business idea is, but how well they seem to be able to describe it and to describe it in similar ways. If they appear to describe different businesses, they may need to take more time deciding what it is they want to accomplish.
Forming and operating an LLC together is not unlike being in a personal relationship. How well do these people know each other? Well, it is up to them to decide if they know each other well enough to be in business together. It is good for the LLC that these people consider some factors they may not have thought about. I'm going to go through some questions that you might ask these potential business owners. And they may not seem to have anything to do with starting a business or creating an LLC, but they're questions for the two owners, two or more owners, to wonder about, how well do they know each other? Would they meet someone, talk about an idea together and then run off and commit their lives together personally? Would they get married together after half a day?
Setting up and running a business together may not be a marriage, but it is similar, has some similar traits to it. It's important that they know some details about each other. For example, how long have they known each other, and why do they want to be in business together? What is it that draws them to each other to set up and operate this business with each other and not with someone else? Or perhaps even why not operate the business by yourself? Why this person? How many marriages and or other committed personal relationships have they each had? How would they describe their relationships? Do they get into and out of relationships rather quickly? Do they always blame the other person for things that don't work out? Can they accept responsibility for their share of problems in relationships? Have they had one long successful relationship for years?
How well this person seems to handle relationships is something for the people to discuss because they're getting into a relationship with each other. Is anyone obligated to pay child support and or alimony, or perhaps a payout pursuant to a property settlement agreement? These are significant financial obligations that might interfere with the ability to qualify for loans and credit. It's also going to be something that an owner with those types of issues is going to have on their mind. If they have trouble meeting those obligation, they're going to be a bit more nervous perhaps about finances. They may be a bit more reluctant to have to contribute additional capital whenever that happens, they may not be able to contribute additional capital. These are, as you know, court ordered obligations that cannot be ignored. If one of the partners has such an obligation, the others need to be aware of it and to be satisfied that they're being handled appropriately.
What is each person's personal credit rating and why is their rating what it is? Do they have great credit ratings or what is it? Why is it? At the beginning of a business in particular, and even throughout the business, certain types of credit applications, certain types of contracts they may enter will require personal guarantees of the owners. And a personal guarantee they might check the credit rating of the owners before they'll accept a personal guarantee. It could become a problem in certain instances. Does anyone have a bad traffic record, including accidents, tickets, and DUIs? Have they ever had their driver's license suspended? Have a valid driver's license now? Do they have and maintain car insurance? Is ownership of the vehicle they drive in their name or in someone else's name?
Having a car and driving a car is a fundamental thing in life in America, and if a person has something that interferes with their ability to have a car titled to them or to drive it, or they have a lot of issues with their car, it's an example, it's an illustration of how they handle the responsibility of being a driver. How will that carry over into the responsibility of being in business? Maybe it does, maybe it doesn't, but it's something to talk about, something to consider.
Does anyone have a record of misdemeanor or felony convictions? Are they still on probation or parole? Having a record by itself may not be as big an issue as it might seem to some, but it matters what the record consists of, how old it is, and whether there are still some consequences that need to be handled. It really is not that unusual for a person to have had a run in with the law when they were in college or starting out, and maybe they've handled those issues, it's all in the past, they've moved on. Maybe it wasn't that big of a deal. Maybe there was all kinds of extenuating circumstances. There's always more to it than just the record, but those things it's good to talk about them. And sometimes a person has questionable records, a questionable past. It may be okay with the owners, they may know about that and say, "It's all right. I don't care about that," that's fine. But they need to understand, I think that this might be an issue.
Do they own or rent their home? Have they each been to the others' homes to see how well they live and how well they maintain their homes? If you go over to someone's house and it's a dump, it might tell you something about how they live, about how they take care of things. If you go to someone's house and it's orderly and to the point that it makes you nervous, well, it tells you that they like detail, they like order. There's a lot of ways to keep a house and for people to be happy to live there. How they do that might be an indication as to how they're also going to keep their office, or the business, or the business location or facility, or how well they are able to organize things, or how well they're able to pay attention to things or to stay on task. How a person lives at home can reveal a bit more about that person. When you sit and look at it and think about it.
Can they legally own a firearm, if not, why not? This is not about whether they want to own a firearm or even about what they think about firearms, but it is a significant thing if someone cannot legally own a firearm. It is very easy to qualify to own a firearm in this country. If a person cannot, it's typically because they have domestic violence convictions, they have a felony conviction, they have specific type of mental illness history. Again, those are things the owners may have discussed and they aren't worried about, but it's not something you want to be surprised about. It's just another clue as to who is this person I'm thinking of going into business with.
Are there issues with alcohol or substance abuse? Even if not, do they have any problems with the use of alcohol or other substances by the other? A lot of people enjoy a drink, a lot of people enjoy various ways to become intoxicated, and it can be handled responsibly. Sometimes a person just goes out and parties. These people are they compatible, can they live with the way each other handles this particular issue or is it a problem? Is one a teetotaler and the other one a party person? They might still work to operate their business together, but it's something they might want to pay attention to. It's a bit more information about determining should these people think again about going into business with each other.
And a question, a pointed question to ask, I think to ask each person, and ask them to think about it seriously, is do you really truly trust this person with your future? Why? Because when they start this business together, if this business is they're going to be their main livelihood, they're really putting each other's futures in each other's hands. It requires a great deal of trust. I think it's very similar to the trust you put in someone else's hands when you decide to become married or to be committed to them for the rest of your life. You're pledging a lot to each other. Do you really trust them this much? If they have hesitation on some of these things, or if these things cause them to rethink things, that's the point. It's not to talk them out of working together, it's to see how well they really know each other before they begin and commit to this new business.
The point actually of these initial considerations is to cause the people to evaluate for themselves, for themselves, it's not for you to judge them, it's for them to understand for themselves how well they each agree on what they are attempting to accomplish, and whether they are really ready to begin this venture with each other. It is their decision to make, and it may not be a decision you or anyone else would make, but if they're happy with it, if they've thought about these things and they agree, "Yeah, I want to do this. We want to do this with each other. Now, help us get this thing organized," it's their decision. But it's still good in my opinion to raise these issues and perhaps other issues you might consider just to get them to think. It never hurts to spend some time thinking.
The operating agreement. There are decisions to be made before the operating agreement can be prepared. Many, if not, all of these decisions would appear relatively easy to make. I have found, however, that some parts of the agreement can be more troublesome than others. I have even had a couple experiences where people changed their mind and decided not to start a business together. The operating agreement is a contract, which is why it is called an agreement. My thought is to make it clear to the owners that they have complete control over the entire content of their operating agreement. Even though state statutes include default language and provisions, I recommend that people consider each of the sections and make their own decision on whether to use a default provision. Everything in the operating agreement should be included because the owners want it to be included exactly as written.
They need to take ownership of their business in every sense of that word. And I do stress that the operating agreement is a contract, it's their personal agreement with each other on how they intend to manage the business, how they intend to meet the legal obligations for maintaining their LLC status. I try to stress that every word in there, every section needs to be because that's how they intend to do it, it's how they want to do it. No one's going to make them meet once a month if they don't want to meet once a month. No one's going to make them divide up their ownership interests in a particular way, it's their decision to do so. It's their decision on all those factors. I want them to understand that they need to seriously take full ownership that whatever is in there it's because they chose to put it in there.
There are certain sections of the operating agreement I like to spend time on with the owners. These may or may not be the most crucial parts of the agreement, but they are in my experience, and they tend to be potential sources of problems if carefully considered. And sometimes people don't appreciate exactly what's involved. First, the name of the business. The name of the business is not usually a source of problems, but I like to ask how they decided on the name they intend to use. How the name was determined can be an interesting story and it may also have been an adventure to pick just the right name. It is not unusual that the name is the result of discussion and compromise. In many situations, the name will have personal significance to the owners. Hopefully, they found the name working well together, and it didn't cause any arguments, and if it did that there are no lingering ill feelings about how the business name became the business name.
Business address. People might not realize they need a physical business address, even if they will not be working out of what they consider to be a physical location. But it's an online business, everything will be handled online through our website. That's fine. But if the statute requires a physical address, then they need to determine what that will be. If the owners each move around quite a bit, then it may not be practical to pick one of their home addresses. They might need to arrange to rent a spot or to find a location, explain to them why they would need to have the physical location. They need to select one that will be consistent without having to change it every year or every few months.
Capital contributions. This issue can be a real source of problems. Nothing says I'm committed to this business like putting up my own cash. However, there are various types of assets that qualifies capital contributions, and other things besides cash are truly needed as capital. I began asking questions when one person is putting up their own cash, or the others are contributing non-cash assets, or agreeing to become obligated on a loan without putting up much or any of their own cash. It may be fine, but it catches my attention and I want to bring it up to the owners. I'm especially concerned though, when someone is given credit for a capital contribution based on their experience and expertise, and or their ability to attract business. You need someone with experience and expertise and you need someone who can attract customers, in fact, it is a crucial thing and that knowledge, that ability might be worth a lot as a type of capital contribution. There's nothing wrong with these types of arrangements as long as everyone understands what they are agreeing to do and to accept from the others.
I always advise people, if you're going to accept non-cash as capital contributions, you need to value whatever the contribution is that's being made by each person, put a cash value on it. And that way it becomes your agreement at the beginning. You put up all this equipment, these furnishings, these supplies, we've valued it at the same amount as the cash I put up. You're putting up your knowledge, your ability, we need that. In fact, without you, we couldn't do this. We're valuing that at this much, which may be the same or different amount than the cash or non-cash assets that someone else is putting up. I think it is especially important to always put a cash value on every non-cash asset accepted as a capital contribution. It's good for accounting purposes, for tax purposes, of course, but it reminds people you are agreeing now that this particular contribution is worth this much in cash that you're putting up. If they have a problem with that or questions about that, then they need to talk about that with each other. They need to get that worked out.
Then I point out that however they decide to handle this, if things go well, and there's lots of money, there probably won't be any problems on this issue. But if things do not go well and things don't always go well forever, there's always going to be bad months, bad periods, bad seasons, there will be problems when things aren't going as well as people like. It's also important, and sometimes a surprise, people need to understand that contributing capital is an ongoing obligation of a business owner. It is not something that you put up all this cash and other asset now, you may have to do it again sooner than you expect. It's not just, we're going to be successful and have our revenues to pay for everything, it might be and that's wonderful, but that's not normal. There's going to be the need, the necessity as time goes by to contribute additional cash.
And if someone's knowledge, talents, and abilities was valued as contribution now, unless they get new talents and abilities, I would hesitate to recommend they accept what they've already accepted and give it more value. They can, but it makes me wonder why. It might be time to go out and get cash, or to all get a loan together. In any event, this is a significant money issue, and money issues tend to be one of the two biggest causes of relationship problems.
Communication and making decisions. This is the second of the two biggest causes of relationship problems, talking to each other. How will the owners meet? How often, and how will they discuss things with each other? How will they make decisions? Will they vote, will they argue with each other? Most likely they'll have some sort of a voting process, but how will they make decisions? What type of vote will make a decision? A majority vote, a three fourth vote, unanimous vote, there's different ways to handle it. Will they share in the management of their LLC, or will they appoint a manager? Do they agree on who the manager should be if that's the case, or do they all want to have an equal voice, they all want to say, no, all of us have to make the decision each time? Or maybe they'll appoint someone to make certain types of decisions and other types of decisions as they define those things, as they describe those things will be decided only after the owners get together, discuss it, and vote on it?
The owners need to agree on how they're going to do these things. They need to talk about it. They need to see it through, carry it through. They all also need to understand that it is especially necessary to keep talking to each other during times of disagreement. They will have disagreement. At the beginning of a relationship it sometimes seems, oh, we'll be fine, we get along so well. And perhaps they do, but there's going to be disagreements. They may or may not be significant agreements, but they need to keep talking to each other. They have to understand you can't get mad and [inaudible 00:26:14].
Sharing profits and losses. This is another money issue. It is also an issue usually related to the ownership interests of each member. Equal owners usually share profits and losses equally, but of course, they can arrange this as they wish. The key points I like to emphasize with the owners are first, if you base ownership interests on the value of each member's capital contribution, and not everyone is contributing the same amount of cash or cash equivalent, don't complain later that someone is getting an unfair share of profit. That might feel that way at times. You agreed at the beginning to value each contribution with the cash dollar value, you agreed to it. You may wish you hadn't, but you did, that's how it is.
No matter what the financial health of an individual, this is the second issue, no matter what the financial health of an individual owner might be at some point, profits and losses must be shared as agreed. This issue can be very hard on the own at times, and needs to be discussed. If there are no profits, then you don't have any money to share. And an experienced entrepreneur, an experienced business owner understands that there will be times when I'm not going to take any money home this month, I better have some leftover from the last time. It's also understood that if things are bad, if we don't have enough money, it's our obligation to get enough money. And that means either we contribute more capital, we get a loan, we make arrangements, but it's our obligation to cover those losses.
Adding new members. A decision to add a new member, the LLC should require a unanimous vote of all current members. However, they decide to handle this, I encourage them to set some basic criteria to determine eligibility for becoming accepted as a new owner. In addition to putting up capital, each new owner should have qualifications relevant to the business of the LLC. You don't just want someone's relative or best friend. You wouldn't hire someone as an employee who couldn't do the job, same thing with a new owner.
What are you going to do when an owner leaves the LLC? At some point, an owner will leave the LLC. This may be sudden and unexpected, such as illness, injury or death, or it may be due to retirement, or accepting a job offer, or someone may have just grown tired of being an owner of the LLC. The owners need to understand that someone will eventually leave the firm no matter how remote that possibility seems at the time. They also need to understand that each member's ownership interest is an asset with value, whether a negative or positive value. Members do not just leave like an employee leaves a job, they must either be paid for their ownership interest, or they may owe the firm to cover their part of a bad financial situation. Sometimes people are surprised by that fact.
Employees. If the LLC will have employees, the discussion needs to explain what it means to be an employer and what it may mean during those times when employees get paid but owners get nothing.
The corporate veil. The corporate veil is similar to a diet. A person can be made to understand what it is and why it is important, but over time it tends to be forgotten and ignored. How many LLCs are being operated with a torn and ripped corporate veil? How many owners of those LLCs really understand that they are truly risking personal liability for things they should be protected from? For each LLC you represent, the status of the corporate veil should be reviewed periodically, at least annually. Take the time necessary to do what you can to make sure the owners are properly protecting and preserving the corporate veil.
Two things that owners sometimes don't appreciate. First is, observing corporate formalities, and second is, how they're going to get or give cash out of the LLC account. Corporate formalities. Clearly, as you set up the business with the owners, that's observing the formalities. There is the articles of incorporation, the operating agreement, any other documents that are prepared in that process that gets them started. But they need to understand that as they have meetings, they need to keep minutes of those meetings. And the minutes don't have to have a particular structure, but they need to at the very least record the date of the meeting, those in attendance, any decisions that were made, perhaps key discussions that were held, and they need to do that.
Now, not every meeting has to have minutes, but they have to have at least an annual meeting. And they might have certain meetings where they discuss particularly significant issues, such as capital contributions, adding a new partner, we have an employment issue, we have a business issue, we have a business opportunity, it could be a good reason or another kind of reason. The big meetings, as they determine, at least the annual meeting, they need to keep minutes, and they need to preserve those minutes, and they need to be in writing. Of course, it can be digital, but it needs to be maintained.
Even a one person LLC, that person needs to understand, yes, you're having a meeting with yourself, you're the only one there, but there are certain issues that when you discuss them, you need to make a note. I discussed this issue today, I decided to do these things. I have advised one person LLCs, often it's like keeping a journal. Just write down in a journal book on those occasions when you make big decisions, that qualifies as minutes. Some people have an impression that minutes require certain types of formalities, and flourishes, and all that, and they don't. It's just keeping track of what you talked about, who talked about it, what you decided.
Also, there are annual reports, at least that need to be filed with the state, there may be other reports that have to be filed with the state or perhaps with other regulatory agencies based upon the business of the LLC. Each of those needs to be filed on time with the correct forms. If there are fees involved, the fees need to be paid and they need to be signed by the proper partner, if it calls for perhaps a managing partner, that person needs to sign it. If the members have created offices for themselves, president, treasurer, and so on, and certain documents need to be signed by the treasurer, that person needs to sign that.
One of the biggest failings is people do not file their annual report with the state. The state may or may not send out notice, it's their obligation anyway. The same thing with other regulatory agencies, they may or may not remind you that you have to file this report. If they're not done, then at least with the state, the LLC could go into default status. And after certain length of time in default status it's revoked and personal liability might attach to things the owners didn't think they would have to be personally liable for. Those are corporate formalities that are in the grand scheme of things very simple to take care of. They might be tedious, they might be inconvenient, but it preserves the corporate veil.
Also, accounting records, accounting forms. I point out that all business records, all accounting forms, tax forms, employment forms, all those types of things that they keep and maintain to assist in simply running the business, maybe not operations of the LLC as to buying and selling its products or its services, but the things you do to keep kind of overhead kinds of things. Those are all also corporate formalities, accounting and tax records in particular because they show budgets, they show how money's spent, they keep track of capital contributions. They keep track of capital accounts. Parties need to understand that, yes, you each have to set up a capital account at least on paper and you need to maintain it. How much have you contributed? Do you owe the firm money? Does the firm owe you money? Are you in good standing? Those are additional formalities that need to be observed.
When it comes to using money, taking money, especially if the firm operated as a sole proprietorship or as a general partnership before it became an LLC, the owner or owners might have been used to simply going down to the ATM and withdrawing money out of the corporate or the business bank account to pay for some personal item. When's your sole proprietorship or general partnership it may not be a best business practice, but you can do it. With an LLC, if you do that, then you are not observing corporate formalities. It's not your money.
I explain to people that the LLC they are creating is look at it as it's your next door neighbor. If you need cash, you don't just go get your neighbors debit card and go to the ATM and take out money, you have to ask the neighbor permission, explain why I need some money, ask the neighbor if they will help you out. And if they do, they do, if they don't, they don't. In the same way. If you need a loan, if you're going to take cash out of the corporate account and it's not part of a draw that's been arranged, it's a loan. There needs to be a loan paper. It doesn't have to be fancy, it just needs to be something that records the fact that this owner borrowed this much money from the LLC on this date and will repay it by this schedule, with interest perhaps.
It's observing the fact that the LLC and the owners are separate legal entities. They need to treat each other as separate legal entities. It's awkward to some people, but they need to made to understand that if they don't do so, they could lose a corporate veil. And if they're sued, depending on the nature of the lawsuit and discovery begins, it is very normal that the plaintiff's attorney is going to have some interrogatories or some other discovery tools to find out are these people maintaining their corporate veil? Because if we can add more defendants, we can add them personally, that's even better. So it's an issue that people can get it, they can intellectually understand it, but to live, it is like being on a diet, it requires effort. It sometimes requires pain and inconvenience, but this is something that simply has to be done. The consequences they're bad.
I also like to explain to of them that even if they are very good about keeping their corporate veil fully intact, they need to understand that each time they personally guarantee a debt or other obligation of the LLC, they are personally responsible for that obligation, period. It's very normal, as you are aware, especially for a new business, but even for an ongoing business, certain loans, certain types of credit, certain contracts require personal guarantees of owners who own more than 10% interest in the business, or maybe all owners. They may need to give those personal guarantees, they may not have much choice because they want whatever it is they're applying for, but even with the corporate veil fully intact and all obligations followed, they remain on the hook personally for those particular obligations.
Disagreement between owners. I like to point out to people that you never really know someone until you either live with them or go into business with them. There are going to be frustrations and disagreements, it's human nature, it's how we are. When two people, two or more people go into business together, some of those issues I addressed previously under initial considerations might come out and reveal something that they wish they would've considered more carefully. You learn a lot about someone's work ethic. You learn a lot about someone's ability to handle money. You learn how they handle stress. Are they good in a tough time? Some people go from zero to panic in one second, others can handle anything. And you don't always know until something happens. And some people are very good handling certain types of problems but not others.
These are things that you learn along the way. And sometimes they're just little things. Maybe someone in their office or in their work area plays music that you find grading on your nerves, and you never realize that's how they did it before. Maybe someone comes in late all the time. Maybe they just come in 10 minutes late, but they work until things are done, they don't worry about leaving early, they don't worry about breaks, they're just always 10 minutes late. Something like that might make one person crazy. That's kind of like in a personal relationship, should the toilet seat be up or down? Does it, in the grand scheme of things, does it matter, but it can make a difference.
That's why it's important under the initial considerations to talk to each other, to try to figure out as well as possible what kind of a work schedule are you anticipating? There are going to be times where we have to cancel personal plans because we need to spend more time with the business. How's that going to go over? There are times where we aren't going to take home any money this month, but we still have to find money to pay our employees. How are we going to do that? How are you going to handle that? How am I going to handle that? How do I explain it to people I live with when we don't have something? When equipment breaks unexpectedly, can we fix it, or are we going to have to get a repair man, or do we have to wait because the repair cannot be made for a while? What are we going to do? What's our backup plan? How do we get things done?
We make an application along with others for a contract with a new customer, we don't get it, so now what do we do? We do get it, and we realize, oh my gosh, now we have to hire more people, we need to increase our capacity. It's an exciting problem to have, but how well will the people work together in handling those types of things? Employment and personnel issues are a huge factor. Some people are quick to want to fire someone or to discipline someone, others are much more forgiving, and then of course, there's everything in between.
Disagreements can come up a lot in dealing with employees. There needs to be some good employment policies which help, there needs to be some procedures. You don't have to spell out how you're going to handle every little thing, and perhaps it may not be advisable to have super detailed policies, depends on your situation, on the client situation, but they need to understand here are the things that we have agreed we will fire someone for without any further notice, you are now fired. And it may not be an all inclusive list, but let's talk about the types of things that we're going to agree will get someone fired immediately. The types of things that we're going to work with someone.
Or perhaps we have a particular employee who's really good at their job, it's a very skilled position, replacing that person would be difficult, something goes wrong with that person, how are we going to handle that? We may not want to lose them, we as owners have to figure out together how to handle that. We have to deal with our emotions later, find a way to work together on that. Or if that person comes and says, "I have a job offer from some other place and they can pay me more money or do other things that you can't do but if you can match that I'll stay," that needs to be talked about. That's a surprise, it's no fun when that happens, and you may or may not be able to keep the person, but you need to be able to talk with your partner, clients need to be told you can talk to your partner about these issues.
These things will come up. There will be other things that come up. There will be changes in the law. There will be changes in tax structure. Those things can upset a perfectly balanced set of books. Now we have more expenses, now we have more things we have to worry about. So people need to be aware of the types of things, and if you understand the nature of their business, or just the nature of business in general, or employment law, you're in a really good position to talk to your business owners about some of the things they need to be prepared for.
Among the things that can be helpful no matter what for the business owners, is to advise them to remain faithful to the terms and conditions of their operating agreement. It's a roadmap. It doesn't answer everything of course, and certainly doesn't discuss or address all the issues that can arise, but it's an outline, at the very least, a roadmap to show you, here's how we're going to handle money, here's how we're going to meet and make decisions. It might remind us, or bring us back to a good place to where we can sit down and work out this problem.
Also, knowing and understanding the common law duties that members of the LLC owe each other and their LLC. They need to understand this, these are legal duties, as you know, people don't always appreciate that these legal duties exist. They exist at common law, they may exist by statute, but they owe to each other and to their LLC the duties of loyalty and good faith, the duty of care, the duty of competence. They must communicate with each other and disclose information to each other. They must use business property for business purposes only. There's a number of duties, it's important and it pays to spend time going through those duties with people.
And also, corresponding with duties or certain rights each member has. One of the big rights, which can be frustrating, is everybody gets to participate in management as described in the operating agreement. And you can't just go change the operating agreement by yourself if you don't like it anymore. If someone, who's an owner, suddenly starts to make bad decisions or bad judgment, you can't just exclude them, except according to the operating agreement. They have a right to participate in management. So if they understand that, then I stress that there's two duties that I think encompass all of them. You have a duty of loyalty and good faith to each other. You're honest with each other, you don't cheat on each other, you're straightforward with each other, you do what you've agreed to do, you have to be that fine upstanding noble person. And it's hard to do that sometimes, but if they work on those two things, they can long way to avoiding some disagreements.
Then I'd like to summarize or point out to people, you will have disagreements at times, no matter what. With the operating agreement, these legal duties, your legal rights, your ability to keep talking to each other, will provide a framework for working through those disagreement, and maybe even avoiding disagreements. And the longer you work together, the more things you work through with each other, the easier it does get to handle things as time goes by. But they need to understand it's not always going to be a good fun day.
Changes in ownership and succession planning. The issue of changes in ownership was addressed in the section on the operating agreement. And the operating agreement should describe how a change in ownership will be handled, how a leaving partner's share of the business will be paid, and if they owe money, how they're going to pay back the firm. Those things should be addressed in the agreement. However, there are some emotional facts of life issues that accompany a change in ownership, or that can accompany a change in ownership. And it can begin with why or the reason for the change in ownership.
Of course, if things are going well, the people work well together and then someone dies unexpectedly, or someone is diagnosed with an illness or has an injury that's going to take them out of the ability to operate the business, it's going to be traumatic. There's grief issues. There are, oh my gosh, what are we going to do issues. Suddenly we have to change everything right now because the world doesn't stop and wait for you. So the owners will have their personal feelings about the person who's leaving for some reason like this, and they may want to help that person and, or their family, but they also have to keep running the business. They have to figure out how to keep that going. They might have to figure out, well, this person who's leaving had this special relationship with this particular customer or this particular agency, we need to make sure we can follow through on that. We also still need to figure out how to value their interest and what to do with it.
Other times a person is going to retire and may say, "I plan to retire next year," but in the meantime business sometimes falls back and people sometimes forget about it, but they're going to retire. And if there's advanced notice, which there should be, it's always very helpful to spend plenty of time preparing for that person to leave the firm and dealing with that. Sometimes the parties argue and they cannot work it out. The business itself might be going well, but one of them says, "I just want out, I don't want to do this anymore." And there's an agreement that, "Okay, fine. You can leave the business. I'll keep the business. I'll keep running," but you have to pay that person their share of the interest, their share of their ownership interest. And that sometimes can become contentious.
I've had several cases that went to trial, where people wanted to leave the firm because of disagreements with each other, and ultimately in each case, the business went out of business and some of them had positive capital accounts, others had negative capital accounts and it just got worse. So change in ownership is going to have a lot of personal issues that come with it. Sometimes a person just, they get a job offer. And you may be surprised, "I didn't know you were looking for a job." "Well, I have been a little bit, or I wasn't, I just got this job offer. It's really good. I want to take it. I don't have to worry about running a business anymore. You can have the business or pay me off what I owe, or if I owe something, I'll pay you."
It can be the person leaving may be very happy and cooperative, or they may not, but it can sometimes feel like a betrayal, like someone is leaving you for someone else. And it may not, but it can be that way. I like to advise business owners that change of ownership is sometimes it's planned, sometimes it's done according to, we see it coming a long distance in the future, but quite often it's a surprise. And the reason, the nature of that surprise can make it much more difficult to deal with in surprising ways, in addition to having to settle up with that person, who's leaving the firm.
Next issue, succession planning. Succession planning may not be an important issue at the beginning of the LLC's life, especially when they're worried about surviving the first year. But if the business is successful, and as time passes, it does become an important issue. Who will take over the business as the owners decide to retire or leave? The place to begin this discussion with the owners is to focus on the minimum qualifications that may have been set for becoming a new owner into the business, as well as the method and process for valuing an owner's interest in the firm. Succession planning ideally is going to be based upon someone is qualified to come in and take over the business, not because it's a relative, or not because it's a friend, or someone in some other defined group. You don't just want a warm body. The focus needs to be on what's best for the LLC.
If the LLC is to continue, if that's the intent and desire, time needs to be spent on deciding who are we going to want to hand this business over to. Also, will all the owners leaving at the same time, or is this going to be a scheduled retirement, they leave at different times? There's a lot of ways to look at it and to address it, but to me, the key for succession planning is the owners need to talk to perhaps their relatives, their kids who might have an expectation that they're going to come in and take over the business. If that's not the case, that owner needs to talk to their family members, it's their responsibility to do so, because what a relative might think is not always what the owners are thinking. Or if one person thinks I want my son or daughter to come in and take over my share of the business, but the others are saying, "That person's an idiot, there's no way," that discussion needs to be held also.
It can be contentious, but succession planning, when it becomes an issue should be based on what's best for the business, why would this person be qualified to take over the business, and who are we going to say cannot take over the business and we need to talk, have those discussions. So whatever the discussion might happen to be, it's good to point out to the business owners that these issues will become issues at some point, and to talk about them.
The end of the business. This issue refers to an acknowledgement that no business is guaranteed to exist forever, or even at all. A business must be operated successfully from the beginning and it must always be successfully operated in the long run, or it will fail. It may not always be possible, but in many instances it is. The end of the business can be recognized far enough in advance that there is time for planning. The end will come one way or the other, maybe through succession planning, but maybe through, it's just not going to work. Owners need to determine for themselves the conditions that when they exist will indicate that the end is coming. Let's try to recognize this from a distance. It can be personally difficult to accept that the end is coming, and some people deny it until it is too late. A planned exit as much as possible is always better than simply locking the doors one day.
There are some things that when they happen are pretty big clues that well, the end might be coming. If we lose a big customer, if we don't get this new account, it's bad, it may not be fatal, but it's going to be bad. If the business has been in decline for a while and it doesn't seem to be getting better, nothing that's attempted seems to make much of a difference, it might be on the way out. It's important for the owners to try to understand, we don't just have problems, we have a business that is dying. And the sooner we can recognize that and accept it the better.
If there is time to implement a closing plan, then arrangements and negotiations can be attempted to deal as well as possible with employees, with lease agreements, contracts, customers, taxes, and other liabilities. It also allows owners to figure out how they will handle any personal guarantees that they may have. As difficult as it can be for their owners to recognize things are not going to get better, it can be even harder for employees. It's their job, they need this income, just like the owners need their business, but employees need their income. So they need to be told as soon as possible, if it's the case, "I'm sorry, but your job's going to end on this date."
If you have lease agreements, did you just sign a lease agreement or are you contemplating one? If it looks bad, you might want to put off entering that new lease agreement. Contracts, customers, taxes, those are all things that need to be surveyed. What do we owe? What we have? What are types of debt that will not go away? Also, how many personal guarantees do we have out there? Because if the business has not enough assets to cover obligations, we're on the hook.
One of the things that sometimes really surprises me is how many people seem to have the idea that the liabilities of a business will simply end on the day the business goes out of business. If that's a belief that people have, and even if it's not, it's an issue that ought to be addressed to make sure they understand that. I'm not sure where they get the idea, but just because obviously the business doesn't exist anymore doesn't mean the obligations go away, especially the personal obligations. There will be contracts that has to be negotiated to an end. There may be language termination, language in the contract that accepts going out of business as a condition for terminating the contract, but there may not, so contracts will have to be reviewed.
Tax obligations, they don't go away, they still need to be paid. Employment wages still need to be paid, even if the owners intend to file a bankruptcy for the LLC, and perhaps for themselves individually, there are certain priority debts, wages, taxes, and so on that won't go away. Also, not handling these things well will leave a bad record for the owners should they ever attempt to start a business again. Depending on circumstances that might be difficult to arrange credit in the future, it might be difficult to get good customers in the future, if the end of a business is handled poorly, it can have an effect, significant effect on future efforts to start new businesses.
It's sometimes good to remind people no matter how enthusiastic they are, no matter how much cash they have at the beginning of their business, your future's not guaranteed. A lot of businesses don't make it to the end of their first year for all kinds of reasons. They're good people with money, they don't make it. You need to understand that this LLC needs to be taken care of and accept the fact that it may not work, but work hard at it. That basic message.
I think that the more realities, and this is kind of a summary for this presentation, the more realities of starting and operating an LLC that are talked of about with the owners, not just the legal things, but these things that I've been talking about, the more helpful and useful your advice to them will become. Sometimes they need a splash of cold water on the face. They may be super idealistic, they may be so excited they can't sit still, that's great, that's a lot of good energy, but a dose of reality is also necessary, and a dose of reality of working together is to me a crucial part of the advice that we give to people who come in and want to start their business as an LLC.