One of the main purposes of forming and operating a limited liability company is right in the name – when the company’s operations are in good order, the owners (or “members”) of the LLC are shielded from any liability generated by the company. A key component of ensuring this liability protection feature remains in place is maintaining proper financial management practices.
Comingling finances between a company and its members is one of the most common errors we see in LLC operation. It is also one of the factors frequently cited by courts when they set aside the liability protection element of an LLC and allow creditors to reach the assets of the members, known as “piercing the veil.” In order to avoid this, LLC finances must be kept completely separate from the finances of the members. Below are some examples:
Bank Accounts - The LLC should have its own bank account, where company income is deposited and from which company expenses are paid.
Company Expenses - The LLC should only pay its own expenses, not personal obligations of its members or expenses of related entities. When a company pays expenses that are properly treated as member expenses, it is an indication to the court that the members consider the company to be the “alter-ego” of the members rather than a separate entity with independent existence.
Capital Contributions - If the LLC requires additional funds, contributions by the members should be formalized as loans or capital contributions. Money should not flow casually between an entity and its members and members should never pay company obligations directly from their own personal funds (or the funds of other, separate entities in which the member owns an interest).
Company Credit Cards - Company credit cards should only be used for expenses related to the company’s operations. Credit card payments should be paid from company funds.
Titling Assets - Assets that are used for an LLC’s business operations should be titled in the name of the company. This includes real estate, office equipment, machinery, and inventory. Any loans secured by company property should also be in the name of the company. Finally, purchase orders (both for the company’s purchase of assets and customers’ purchases from the company) should identify the company as the purchaser or seller, as the case may be.
It is easy for closely-held businesses to run afoul of these guidelines – we live in a busy world and sometimes it feels easier to just “take care of” a payment or purchase and sort out the particulars later. But careful, rigorous money management is critically important because it help companies maintain liability protection for their members. If an improper personal charge or payment is made in error, be sure to document it as an owner’s draw to be consistent with your tax-reporting obligations. If you have questions about setting up proper financial systems for your new business, or getting an existing business on the right track, contact us for more information.