LLCs are often ill-suited for growing AEC firms, leading to legal entanglements and hindrances later on.
I am no attorney and I don’t provide legal advice; neither does Zweig Group. That said, the attorneys who put so many new AEC companies into an LLC are like dentists who give away candy that rips out your fillings. They are literally creating problems for their clients and future work for themselves by doing so.
LLCs were never intended to be a legal structure used to run a going concern. They typically have a limited lifespan and were designed to do things such as perform a real estate development project. One or a few people pool their resources to buy a piece of property and improve it. The project is done and the LLC is liquidated. There aren’t owners coming and going throughout the project. There’s no board of directors, bylaws, or shareholder agreements. The way these LLC operating agreements are written, every decision of any consequence requires unanimity. You don’t have stock you can buy and sell governed by a shareholder agreement with a valuation methodology and buyback terms. It’s fine for something that will last a year or two, but it’s unwieldy when you try to apply that to a growing AEC firm.
Sure, if you want a passthrough entity for tax purposes and have non-U.S. citizens as owners, an LLC may make sense because you cannot do that with an S-corp. But otherwise, as a legal form for a legitimate AEC firm that hopes to grow and create value for its owners, an LLC will eventually become paralyzing if the ownership has to change. And in my experience, it usually does. A member doesn’t perform and needs to go. A member wants to go do something else. A member gets sick or dies and has to be bought out. Then, nine times out of 10, there is a dispute that must be resolved by attorneys.
If you are an entrepreneurial small firm owner who is currently running your business as an LLC, please go see your attorney and accountant soon and talk to them about your legal form. It may be time to convert to a corporation and save yourself all kinds of grief down the road. Corporations are far more flexible. My guess is that with a corporation, you will be in a better position to raise equity capital from your employees or outsiders if you do. You can have a valuation methodology that penalizes a shareholder who wants to compete, whereas typical non-competition agreements are getting harder and harder to enforce, different buyback terms spelled out in a shareholder agreement won’t be. And you will be less likely to have disputes later – disputes that always seem to come at an inconvenient time and will distract you from selling work, doing work, getting paid, and making a profit – all the stuff you really should be focused on!
So, what do you think? Will you please get some legal and accounting help and deal with this potential problem before it bites you in the hindquarters – or not? I have seen the aftermath of choosing the wrong legal form for a business and it’s not fun. Get smart – think ahead – and set the stage for your future success!
Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.