The Basics of LLCs: Limited Liability Companies

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  • 0:06 General Structure and…
  • 1:14 Flexibility Through…
  • 2:06 Member-Managed vs.…
  • 2:59 Limited Liability
  • 3:32 Pass-Through Taxation
  • 4:55 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

The limited liability company is one of the most popular business organizational forms for small and medium-sized businesses. In this lesson, you'll learn about the key characteristics of a limited liability company. A short quiz follows.

General Structure

Meet Peter, Paul, and Mary. They want to start a vintage record store. One of the first things they have to decide is what type of business association will they use for their store. They perform some research and find that they like the flexibility of a partnership but are not too happy to find out that they will be personally liable for the debts and negligence of the partnership.

They love the fact that a corporation offers them protection from personal liability but are disappointed to find out that corporations can be expensive and complicated to run. The fact that corporations are subject to two levels of income taxation is also a deal breaker. But they do find a solution in a limited liability company (LLC), which has characteristics of both partnerships and corporations.


Peter, Paul, and Mary can form a limited liability company by filing articles of organization with the secretary of state in the state where they wish to form the LLC. As owners, Peter, Paul and Mary are called members of the LLC.

Flexibility Through the Operating Agreement

A limited liability company offers its members a great amount of flexibility similar to the flexibility found in partnerships. Unlike a corporation, there are a few statutory requirements regarding the operations of an LLC. Peter, Paul, and Mary write an operating agreement, which is the primary document that governs the operation of the company and outlines the rights and responsibilities of its members. Operating agreements often include:

  • The purpose of the business
  • How the LLC will be managed
  • Length of existence, which can be perpetual
  • Accounting methods to be used
  • Appointments of managers, if any
  • Interim distributions of profits and losses
  • Transferability of ownership interests and buy-outs

Member-Managed vs. Manager-Managed

Peter, Paul, and Mary also have the option to have their LLC managed by members or managers. A member-managed LLC is managed by its members, like a partnership. All members participate and have a say in all business decisions. A problem may occur in member-managed LLCs if there is an even number of members because a deadlock can occur. However, that's not going to be a problem for Peter, Paul, and Mary.

On the other hand, a manager-managed LLC is managed more like a corporation. In a manager-managed LLC, members appoint one or more managers to manage the LLC. The managers can be members but don't have to be. Peter, Paul, and Mary decide they all want an equal say in their record store's daily operations, so they opt for member management.

Limited Liability

Peter, Paul, and Mary's LLC also provides them limited liability just like a corporation. This means that they are only risking their investment in the LLC. If the LLC doesn't have enough money to pay debts or other financial obligations, creditors cannot go after the personal assets of Peter, Paul, and Mary. Moreover, if someone gets hurt at their store, such as slipping on a wet floor, the injured person can only sue the business, not Peter, Paul, and Mary.

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