Hi, I'm Attorney Elizabeth Potts Weinstein. Today, I'll discuss the top five mistakes people make when setting up their LLCs, particularly small businesses with one or just a few owners. Understanding these common pitfalls is crucial to maintaining the liability protection an LLC offers.

What is an LLC?

A Limited Liability Company (LLC) is a legal structure for a business. While you could also form a corporation, partnership, or sole proprietorship, an LLC is often preferred for its simplicity and benefits, such as limited liability protection. This protection shields your personal assets if the business is sued, can't pay its debts, or goes bankrupt. However, several common mistakes can jeopardize this protection.

1. Not Having a Written Operating Agreement

An operating agreement outlines how the LLC will function, similar to a partnership agreement. Although not legally required in most states, having one is crucial, even for single-owner LLCs. This document helps establish the legitimacy of your business and sets ground rules, which can prevent misunderstandings among multiple owners regarding roles, responsibilities, and the process for handling disputes or exits.

1A. Not Signing the Operating Agreement

Many people obtain an operating agreement but fail to sign it. An unsigned agreement is ineffective, so ensure that all members sign the document to make it valid.

2. Neglecting Required Annual Filings

Every state requires some form of annual or biennial filing to keep the LLC active. This could be a Statement of Information in California or an Annual Report in other states. Missing these filings can lead to administrative dissolution of your LLC, meaning it no longer legally exists, and you lose liability protection. Set calendar reminders to ensure these filings are completed on time.

3. Mixing Personal and Business Finances

One of the biggest mistakes small business owners make is co-mingling personal and business funds. It's essential to keep these finances separate. Distribute profits to yourself through proper channels—write a check, run payroll, or transfer funds with proper documentation. This separation is necessary for maintaining the LLC's liability protection.

4. Poor Record Keeping

Maintaining accurate records is vital for any business. This doesn't have to be complicated; a simple spreadsheet or paper ledger can suffice. Document all income, expenses, and significant business decisions. Having a thorough record helps in case of an audit and proves the legitimacy of your business operations. Always formalize agreements and decisions, even if they're informal conversations, to avoid future disputes.

5. Not Properly Closing the LLC

If you decide to stop operating your LLC, you must formally dissolve it. This process includes paying off all debts, filing final tax returns, and completing any required final filings. Failing to do so can result in ongoing liabilities and administrative penalties. Properly closing the LLC ensures that no future issues arise from an inactive business entity.

Conclusion

Avoiding these common mistakes can help you maintain the liability protection that an LLC provides and ensure smooth business operations. If you have any questions or need further assistance, feel free to leave a comment below, join our free Discord, or sign up for our Patreon.