We often get questions about LLC stockholders, bylaws, stock certificates, directors, minutes and sometimes a Limited Liability “Corporation.” It’s understandable to have questions about how LLCs are structured and operate. Here’s what you need to know.
Typically, “stock” is not the term used for LLC ownership shares. In most LLCs, the LLC Agreement designates a certain number of what it calls “membership units” or “member interests” and may break them down further into a certain number of Voting Units and Nonvoting Units. This bifurcation is similar to how corporations can authorize voting and nonvoting stock, usually called “common” and “preferred” shares, respectively.
Stock, in the context of a corporation, means units of ownership that give its holders rights to a percentage of ownership, a certain number of votes, and possibly a certain dividend. Membership is used in the context of an LLC because in addition to the rights stockholders possess, LLC members more often manage the day to day business of an LLC, which in a corporation is a right usually left to the Directors.
The simpler structure of vesting the rights of shareholders, directors and managers all in one type of person is one reason many people choose to form an LLC instead of a corporation.
Because LLCs do not issue stock, there are not “shareholders” or “stockholders” in LLCs. LLCs do have “members,” which hold ownership units in the LLC. There can be different classes of membership units with different rights and duties. For example, an LLC can designate Voting and Non-Voting membership units.
Limited Liability Companies do not have stock or bylaws. In fact, LLCs have almost no features of corporations. Legal professionals refer to LLCs as “unincorporated entities” because they are creatures of contract, rather than corporations, which are creatures of statute.
But what does it mean to be a “creature of contract”? Doesn’t the Delaware LLC Act authorize LLCs? Does that not make them statutory?
The general answer is that corporations have statutory formalities and hierarchies they must follow and cannot waive. Corporations have “default rules”, many of which the owners cannot change.
In the Delaware LLC, there is not a default rule to establish the LLC framework. Instead, its internal contract can establish the entire framework for an LLC. This contract is called its “Operating Agreement.” After a general notice filing with the formation jurisdiction, called a Certificate of Formation in Delaware, the LLC’s private Operating Agreement takes over to set forth the ownership structure and management structure. It may provide for a broad business purpose or a single business purpose. The Agreement can give managers broad powers or narrow powers. It can provide for member liability or limit member liability for capital calls and other obligations.
The LLC does not have stock or stockholders. Instead, the Operating Agreement has membership interests. The Operating Agreement lists the membership interests of each member rather than in separate member certificates. The Operating Agreement determines the rights of each type of membership interest.
Delaware allows for maximum flexibility of contract when entering into an Operating Agreement. In exceedingly rare situations, LLC members use this freedom to “opt into” the Delaware General Corporation Law and establish members to establish rights of corporate stockholders who vote for directors who appoint officers. That anomalous situation is far from the norm. Most Delaware LLCs have owners called members and operators called managers. The Operating Agreement sets forth their powers and duties. This structure is much less bureaucratic than the corporate formalities which makes LLCs more popular.
When deciding where to form your company, consider that Delaware has advantages over your home state that may benefit you. Go
