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FERNANDES LAW FIRM

I want to provide you with some guidelines that are important in realizing the benefits a limited liability company since doing business in the form of an LLC provides limited liability for all members and advantageous partnership treatment for federal income tax purposes. This particular combination of benefits is not available with any other form of business entity, and you will need to follow certain guidelines to be certain that the benefits remain available. 1. Separate Entity

In order to obtain limited liability for members, it is critical that an LLC be operated as a business entity that is separate from its members. If an LLC is operated as an alter ego of the members, creditors of the LLC may be able to recover their claims from the members rather than being limited to recovery from the LLC itself.

a. Adequate Assets

In order to function as a separate entity, an LLC needs sufficient assets to operate its business. At the time your LLC is organized the company will need enough capital to have a reasonable chance of being successful. Ownership of the cash or assets needs to be transferred to the LLC; nor should substantial distributions of cash or assets should be made to members until your LLC has accumulated sufficient profits to fund the distributions.

Applicable state law prohibits an LLC from making any distribution that would cause the LLC’s liabilities to exceed its assets or would prevent the LLC from paying its obligations as they become due in the ordinary course of business. If distributions are made in violation of these insolvency restrictions, the members receiving the distributions may be required to repay the LLC at the behest of other members or the LLC’s creditors.

b. Separate Assets

As a separate entity, your LLC needs to have its own assets. The LLC must have a separate bank account and should hold title to its assets in its own name. Under no circumstances should the personal funds, assets, or accounts of members be mixed with those of the LLC. Similarly, LLC funds should never be used to pay personal expenses of members, to make personal investments for members, or for any other purposes not related to the LLC’s business.

Cash or other assets should be transferred to members by the LLC in only three situations—to make distributions permitted under the terms of the operating agreement and the

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applicable state LLC statute, to reimburse members for reasonable expenses incurred on behalf of the LLC, and pay reasonable compensation for services performed by members for the LLC, the amount of which has been agreed upon in advance. Since reimbursement of expenses and payment of compensation can be the equivalent of a distribution, particularly if the expenses or compensation are unreasonable in nature or amount, the insolvency restrictions that are discussed above can apply, and these restrictions need to be considered whenever cash or assets are transferred to members.

If assets owned by a member of your LLC are used by the LLC, appropriate arrangements should be made and documented. For example, if a member leases an office, production facility, or warehouse to the LLC, there should be a written lease agreement, and the terms should be fair to the LLC. It’s a good idea to document loans from members to the LLC with promissory notes and to provide for a reasonable rate of interest that is actually paid by the LLC. In the absence of these precautions, the LLC and its members may appear to be one and the same individual or entity, which jeopardizes the members’ limited liability protections.

c. Separate Operations

An LLC must be operated as an entity that is separate from its members. The business of your LLC should be conducted in the name of the LLC, and the LLC’s name should be used on all agreements, contracts, leases, orders, and other arrangements entered into by the LLC. This name should also be used on all products, signs, advertisements, correspondence, business cards, telephone directory listings, and similar items. The LLC will need to obtain and carry its own insurance and to file its own income and employment tax returns ask for assistance with setting up the books and records of the LLC from your accountant.

An LLC can only act through its members. But when one of you is acting for your LLC, remember that you are acting an agent of the LLC and not in your individual capacity. For example, members should sign all documents on behalf of the LLC as follows: “[Name of LLC] by [Name of Member], Member.” This makes is clear that the member is signing in a representative capacity and is not accepting personal liability for the performance of the obligations spelled out in the agreement. 2. Income Tax Matters

The LLC will be treated as a partnership for federal income tax purposes unless you elect to be taxed as a corporation. Electing to be taxed as a corporation can involve very serious income tax consequences that may be disadvantageous to you either now or in the future. There can be adverse tax consequences even if your LLC elects to be taxed as an S corporation. Consequently, you should not make the election to be taxed as corporation without carefully considering the ramifications with your accountant.

There is generally far less tax cost associated with converting a partnership to a

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corporation than there is in converting a corporation to a partnership. When in doubt, it’s better to start with partnership classification rather than making an election to be taxed as a corporation.

A partnership must file a federal information income tax return each year. Any income or loss shown on this return passes through to the members and must be reported on their individual income tax returns. Your LLC may also be required to file income tax returns in states and localities in which it operates. You should consult with your certified public accountant regarding compliance with applicable income and other tax filing requirements.

Although the LLC will be taxed as a partnership, it should not be held out to the public as a partnership. An LLC provides limited liability for all members, and a partnership does not. If members of an LLC identify themselves as partners when dealing with third parties, there is a risk that creditors of the LLC will be able to assert their claims against the members individually. 3. Operating Agreement

The operating agreement LLC provides a road map for conducting LLC operations in a manner that preserves the benefits of this form of doing business. You should refer to the operating agreement periodically to be certain that your LLC’s operations are being conducted properly.

Among other things, you should hold a member meeting whenever a major decision requiring the consent of the members is to be made. These decisions include changing the nature of the business of the LLC, making optional distributions to members, selling all or a substantial part of the assets of the LLC, entering into transactions involving a conflict of interest with a member, admitting a new member, and continuing the LLC following the death, incapacity, withdrawal, expulsion, bankruptcy, or dissolution of a member.

A permanent written record should be made of all member meetings indicating who was present at the meeting, what action was taken at the meeting, and the number of members voting in favor of or against each action taken. The record of meetings should be kept at the principal office of the LLC. The operating agreement contains a list of the other types of records and information that must be maintained at that location.

The operating agreement will also contain restrictions on the transfer of members’ interests and provisions for the admission of new members. Members will be required to follow a specific process if they want to transfer their interests to others, and formal action by the members is required to admit new members to the LLC. The procedures in the operating agreement should be followed in order to prevent creditors of members or other third parties from acquiring rights as members of the LLC.

The operating agreement also contains provisions relating to the death, incapacity, withdrawal, expulsion, bankruptcy, or dissolution of a member. These provisions should be consulted if any of these events occur. Prompt action may be required to prevent dissolution of the LLC.

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Although LLCs are not required to hold annual member meetings, it’s a good idea for the

members to review the operations of the LLC at least annually. This may be a good time to review the operating agreement to be certain the LLC remains in compliance with its terms. 4. Further Advice

Neither this Memo nor the LLC’s operating agreement can anticipate all issues that may arise in the operation of your LLC, and neither document is likely to address all questions. Accordingly, I encourage you to seek further legal advice if you have questions and particularly before undertaking major changes or transactions affecting the LLC.

Please feel free to contact me if you need assistance with any of these matters or if questions arise regarding the day-to-day operation of your LLC. I have appreciated this opportunity to be of service to you and look forward to working with you in the future.