Why you want a lawyer to form your entity

The main reason why you want a competent business lawyer to form your LLC is because non-lawyer formed LLCs don't offer the same amount of protection from personal liability and from creditors. I'll discuss why below.

Protection from Personal Liability

The bare minimum required for the bare minimum personal liability protection is to file a legal document with the state's regulatory body covering LLCs. In Texas, that is paying a filing fee to the Secretary of State of Texas, as well as filing a legal document called the "Certificate of Formation". In Michigan, we call this document the Articles of Organization and it is filed with the Michigan Department of Licensing and Regulatory Affairs along with a filing fee.

You can think of a Certificate of Formation or Articles of Organization like a birth certificate for the company. It lists basic vital information and is designed to put the public and the state on notice that the LLC was "born".

After you receive back your proof of filing, you theoretically have personal liability protection from your business activities with the LLC. Except you're at risk of losing the personal liability protection for many different reasons including but not limited to:

  1. Failure to explicitly limit the personal liability of members and managers
  2. No Operating Agreement or Company Agreement
  3. Poor Operating Agreement or Company Agreement
  4. Failure to hold owner meetings
  5. Failure to maintain records
  6. Failure to maintain ownership records
  7. Improper Capitalization
  8. Funding LLC improperly
  9. Signing contracts intended for the LLC incorrectly
  10. Failure to file periodic reports
  11. Failure to file/pay taxes
  12. Using a Manager-managed structure without complying with Federal and State securities regulation issues
  13. And so on...

The above is just a partial list of things that can lead to piercing the LLC's liability shield. While it's true that it is hard to pierce the liability shield, it can and does happen. If your LLC is sued in the future, which kind of LLC do you want: do you want a DIY or non-lawyer service to do the bare minimum? Or would you rather be secure in knowing that you went above and beyond the minimum and added in substantially stronger asset protections? Without good LLC documents, you're making your defense lawyer fight an uphill battle to keep the protection in place that you thought you had from the beginning. You need your LLC to actually protect you and stand up in court for you, as opposed to sitting there and looking official but folding at the first sign of a fight.

Is using a non-lawyer service or DIY really a gamble that you want to make? Save a few hundred dollars up front to risk a virtually unlimited amount? That's a high-risk low-reward behavior in my book. Prudent investors make low-risk high-reward or high-risk higher-reward choices; not the other way around.

Protection from Creditors

Let's switch gears and return to the Certificate of Formation and how it can give the LLC (and indirectly you personally) more protection from creditors. State governments typically provide a bare-bones form for free that can be used to file an LLC. Go on, go download the form from here right now and take a peek:

You'll see some basic instructions near the beginning on how to do the manual motions to file the form, as well as how to pay the filing fee. Then you'll get to the form.

Go ahead and read it, it will only take a few seconds because there's really nothing of substance in it other than some names and addresses. This level of detail is typically what you get on a non-lawyer form-service or DIY LLC formation. There's nothing wrong with it as far as State law is concerned; but, it can do so much more for investors when given more thought, time, and expertise. Don't assume that just because it's a state form means that it's anything more than the bare minimum required to get your proof filing back from the State government.

Notice that it does not explicitly limit any personal liability of any member or manager. Notice on the Michigan form that there is no simple check the box for a manager-managed option.

A complex Certificate of Formation or Articles of Organization drafted by a competent lawyer can go above and beyond the bare minimum and do several important things, including but not limited to the following:

  1. State the owners' agreements before formation
  2. Set certain provisions in stone
  3. Give public notice of certain provisions in the company agreement
  4. Set the taxation choice of the entity
  5. Give the public notice of restrictions on transfer of ownership interests
  6. Create multiple classes of members, with at least one class having little to no rights to "trap" or discourage creditors
  7. Set a buy-sell agreement

Multiple Classes of Members

The most important ability in my opinion is to create multiple classes of members. Let's say you have Class A members and Class F members. Class A members have all the normal rights and responsibilities of members for your company and you don't include any Class F members at formation. But, later, one of your co-owner members gets sued for a bad car wreck, and loses his life's savings and his ownership interest in your LLC! The creditor now steps into your co-owner's place, becoming a new co-owner. Do you really want to have to make management choices with and pay some third party creditor of your ex co-owner? That sure sounds like a bad forced wedding. The good news is, you can word your formation documents to vastly reduce this scenario.

Complex formation documents could be drafted to make the creditor automatically become a Class F member with no voting rights, and no ability to receive distributions (that's mean money and property) unless all the Class A members agree. Not only does this help you out tremendously in that you can pretty much ignore Class F except when at annual meetings, but, it helps out your co-owner. Maybe that Plaintiff's lawyer would have researched your co-owner's assets and decided that he'd never get a penny out of the LLC. Maybe that lawyer wouldn't have even sued in the first place; or, maybe he would have settled for much less than before.

But it costs more than a bare-bones formation!

Of course it costs more! The stakes are high and precision drafting is necessary. But, compared to the risks of not having the extra protections of competent legal representation, this protection is relatively cheap. And when you need the protection and don't have it, the protection becomes priceless. Like many things in the legal realm, the choice is spend a little more now for a big advantage in the future, or save your money now and carry on with unnecessary risk(s).