Articles Posted in Limited Liability Company

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California has a somewhat confusing answer to the question of whether LLC interests are considered securities in our state. In some situations they are, and in others, they are not. Here we explain when they are and when they are not. If an LLC interest is considered a security it can have significant regulatory implications, particularly when the interest transferred or offered for sale. There are ways around these regulations, but the process can require additional work and filings and is not a sure thing.

When LLC Interests are Considered Securities

California’s first LLC law was called the Beverly-Killea Act. When it became law the legislature amended the corporations code. This amendment provided that a security includes an interest in a limited liability company. So this is the default position. However, this is not the end of the discussion. The legislature also carved out some substantial exceptions to this general rule.

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A new law important to certain foreign LLCs went into effect in California on September 15, 2014. According to the Imperial Valley News, Governor Brown signed the law that day, and it includes a clause that indicates that the law takes effect immediately. Known as AB 1143, the law applies to taxes that must now be paid by some businesses who were previously exempt, and changes California property tax law.

Change to Property Tax Law

First, the bill changed property tax law. Prior to the enactment of the new law, California property tax laws required that, “when valuing property by comparison with sales of other properties, that the properties be sufficiently near, and be sufficiently alike the property being valued.” The new law changes that definition. Now the definition says:

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In creating a start-up, it is important to form the business as the type of legal entity that best suits its needs and goals. Because there are numerous forms of entities to choose from, each with their advantages and disadvantages, choice of entity can be, absent expertise, a daunting task.

The three most common types of entities to choose from are Corporations, Limited Liability Companies, and General Partnerships. Often, the manner in which the start-up is to be funded is a primary factor in entity selection. For example, if you are seeking funding from family, friends, or angel investors, it makes sense to form as an LLC. This is because an LLC is a “pass-through” entity: it does not have entity-level taxation. In other words, it is the responsibility of the LLC’s shareholders and members to pay taxes on the entity profits relative to their respective ownerships portions. In addition to this single layer of taxation, LLCs are also an attractive choice because an LLC’s owners, or “members,” are not personally liable for the debts of the company.

Some of the most famous companies in the world began as start-up LLCs:

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Building a business is not easy. It takes a lot of time, energy and money. But if you are lucky, you end up with a successful brand that stands for quality. At some point, you may want to sell your company, allowing it to live on and grow with someone else. If you do plan to sell your business, there are a lot of things to consider.

Take for example the old California case of Mahlstedt v. Fugit. In this case, C. A. Fugit sold his orchard heating business to J. F. Mahlstedt. For five thousand dollars, Mahlstedt received all salable goods used in the business, all machinery used in the business, patents for e heater and items used in advertising. Mahlstedt also received current customer information and promised to keep prices similar. Fugit also promised to refrain from entering into the orchard heater business as a manufacturer or owner in whole or in part, for a least ten years or to act as a salesman or representative of any orchard heater company. This case focuses on the last promise.

About four years after selling his business, Fugit partnered with Mr. Fabrey, who also manufactures orchard heaters in the same area as Mahlstedt’s orchard. The created the Fugit-Fabry Company and advertised that the company was prepared to furnish replacement parts for orchard heating systems already installed or new systems. This use of the Fugit’s name to sell heaters, prompted Mahlstedt to sue Fugit for failing to comply with the sales contract.

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We have written several posts in the past about some strategic choices faced by a person or persons who are establishing a limited liability company. These include important considerations such as the method of taxation, the manner in which the constituent members are paid, and the things to be addressed in the company charter or operating agreement. There is one choice, however, that some LLC novices neglect to consider until the choice is laid before them by a California business lawyer: Should the limited liability company be managed by its constituent members, or should it appoint people for the express purpose of handling the managerial duties?4774087006_f73cd99ea1.jpg

The short answer is the same frustrating answer that business clients will often hear from attorneys: “It depends.” What does it depend on exactly? More often than not, it depends on the size of the company (the number of members), the aptitude of the individual members to perform managerial tasks, and, distinctly, the desire of an individual member to perform managerial tasks.

For most LLCs, the size of the company is the chief deciding factor. The vast majority of LLCs are comprised of one or two members. Many others are comprised of only a handful of members. When the company size is so small in terms of membership, the individual members are more likely to want a stake in the management of the company. The classic case is that of a small business. Suppose two best friends open a restaurant. Both friends are almost always going to want a stake in the management and direction of the company (such as organizational structure, addition and subtraction of members, or acquisition of company assets) as well as in the day-to-day operations of the business (e.g. employees, recipes, menus, advertising). Although there are two distinct categories of company operations, a team of two members is likely to want to be involved in both.