The Problem: Managing Liability Across Different Ventures
Many business owners manage multiple ventures. This often entails dealing with different types of risks and liabilities. Whether selling different lines of products or operating multiple services within a business, it is really important to keep liabilities isolated to protect assets. For example, consider a business owner who owns both a restaurant and a catering business. In the event that a customer sued the restaurant for something like a slip-and-fall accident, the owner’s catering business could also be at risk if the ventures are not legally separated. Without proper legal structures, a lawsuit or financial issue affecting one part of the business could easily spill over, putting the entire business at risk. For this reason, business owners should look for ways to separate liability across their ventures and ensure that issues in one area don't threaten the stability and success of the others.
Liability Management
Many
states offer the opportunity for businesses to incorporate Series Limited
Liability Companies (LLCs). This structure serves as a flexible way to manage
liability across multiple business ventures by allowing for separate “series”
within a single LLC, each with its own assets, liabilities, and operations.[1] However, Series LLCs aren’t available in
states such as Michigan. For that reason, it is essential for business owners
and entrepreneurs in states like Michigan to explore the alternative options
they have to protect their ventures from these risks. Luckily, there are
several routes a business can take that can help it effectively isolate
liabilities, ensuring that issues in one area don’t place the success of the
entire operation in harm's way. Here are some options that your business can
take to manage risk efficiently.
Parent Companies and Holding Companies
While
“holding company” and “parent company” are often used interchangeably, the two
serve different functions. Both holding companies and parent companies are
companies that own a controlling interest in one or more companies. [3]
While parent companies engage in the direct business operations of its
subsidiaries/divisions, a holding company does not. [4] A holding company primarily
exists to own assets and control other companies. Since both of these companies
are technically not legal structures, they can take the form of different
entity structures such as an LLC, S Corp, or C Corp.
Holding Company Pros:
-
Isolation
of liability of the holding company and subsidiaries
-
The
separate corporate identities can provide tax benefits
-
ex.)
a holding company can receive dividends from its subsidiaries without those
dividends being subject to double taxation, provided certain conditions are
met.
- ex.) holding companies can benefit from the ability to offset profits and losses among subsidiaries, which can reduce the overall tax liability
Holding Company Cons:
-
Limited
operational control of subsidiaries
-
More
complex management can be an administrative burden
- May complicate tax and legal considerations
Parent Company Pros:
-
Isolation
of liability of the parent company and subsidiaries
-
Operational
control of subsidiaries
- Subsidiaries can benefit from being supported by the parent company
Parent Company Cons:
-
There
is a risk of liability if the parent company is too involved in the subsidiary
operations
-
May
lead to complicated governance structures
Separate
Standalone Entities for Each Venture
Another
approach to navigating liability across multiple ventures is to create separate
standalone entities (i.e. LLCs or corporations) for each business activity. For
instance, imagine the hypothetical business owner mentioned earlier in this
post formed two separate LLCs, one for his restaurant and one for his catering
business. This would ensure that if one venture faces legal trouble, the other
would be insulated from that harm.
Pros of Standalone Entities:
-
Provides clear asset protection for each entity (If one venture
incurs debt or faces a lawsuit, creditors cannot target the assets of the other
entity)
-
Setting up as different entities can provide tax benefits
-
For instance, having multiple LLCs would entail a pass through
taxation structure for each LLC
-
Setting up certain separate entities, such as LLCs, can be
relatively simple
Cons of Standalone Entities:
-
Managing multiple entities can be complex and can lead to higher
administrative costs
-
May require careful bookkeeping to keep each entity’s finances
and operations separate
-
Additionally, running multiple entities might complicate tax
filings [5]
Deciding which standalone entity ( i.e. LLC or corporation) to incorporate as depends on factors such as tax considerations, liability protection, management preferences, and future business plans. Each structure has its own set of advantages and disadvantages that should be carefully evaluated in the context of the specific business needs and goals.[6]
Multi-Member LLCs with Clear Operating Agreements
Another
viable option could be to employ the standard LLC structure. While many entity
structures offer liability protection, LLCs are renowned for their flexible
nature. [7]
Multi-member LLCs can be structured in a way that helps manage liability by
having detailed operating agreements. If expressed in an operating agreement,
Michigan law allows for the indemnification and insurance of members, managers,
or other persons against liabilities or expenses incurred, except in cases of
certain misconduct.[8] An
indemnification clause in an operating agreement typically allows or requires
an LLC to pay or promise to pay the LLC members if they face damages or losses
for particular activities. However, an
operating agreement cannot eliminate liability for specific wrongful acts such
as receiving an unauthorized financial benefit, violating the law, or acts
committed before the provision became effective.[9] Imagine, for instance, the
previously mentioned business owner operated his restaurant and catering
services under the same LLC. If the catering venture committed some wrongful
act and was sued, the operating agreement of this LLC could hypothetically
indemnify the chef of the restaurant. However, the operating agreement could
not insulate the restaurant from liability for the wrongful act of the catering
company. This means that while individual members or managers can be
indemnified, the LLC itself remains liable for its obligations and wrongful
acts. [10]
Pros:
-
The single LLC setup is less complex than forming multiple
separate entities
-
Operating agreements can include provisions for indemnification
and limit the monetary liability of members and managers
-
LLCs provide flexibility in management and profit-sharing
-
Well-drafted operating agreements can also help prevent disputes
among members [11]
Cons:
-
This approach requires clear, thorough agreements to be
effective
-
Operating agreements cannot fully insulate the entire company from liability for the actions
of a specific department
-
Without precise language, there could be confusion or
disagreements that lead to liability risks
-
This structure may not offer as strong liability separation as
using separate independent LLCs [12]
Choosing
the Right Structure: Key Considerations
As a
business owner, the structure that you choose for managing liability across
your multiple ventures depends on a number of factors. You need to carefully
evaluate the nature and structure of your business, the potential liability
risks that can be incurred, and the administrative capacity of the business.
Moreover, it is important to consider the tax implications that may come with
the structures that you are considering. Here are a few key questions to guide
your decision-making process:
● How much risk is associated with each of
your ventures, and how important is it to isolate these risks?
● Would separating the ventures simplify
management, or could it introduce more complexity?
● How much do you value keeping costs low
and limiting administrative burden?
● What are the potential tax benefits or
drawbacks that come along with each structure?
Conclusion
Managing liability across different
ventures is a crucial concern for many businesses. Although Series LLCs offer a
useful structure to navigate this liability in many states, Michigan business
owners need alternative strategies. By considering structural options such as
holding companies, separate entities, and multi-member LLCs, businesses can
protect their assets and set themselves up for successful and efficient
operation.
[1]
https://www.nolo.com/legal-encyclopedia/what-is-series-llc.html
[2]
https://www.wikihow.com/Form-a-Holding-Company
[3]
https://www.investopedia.com/terms/h/holdingcompany.asp
[4] Id.
[5]
https://www.bpm.com/insights/multiple-llc-pros-and-cons/
[6] 1 Financial Mgt & Acctng -
Construction Industry § 9.01 (2024)
[7]
https://www.investopedia.com/articles/investing/091014/basics-forming-limited-liability-company-llc.asp
[8] §
450.4216. Limited liability company; powers.
[9] §
450.4407. Managers; eliminating or limiting liability; exceptions
[10] MCLS § 450.4905
[11]
https://www.investopedia.com/articles/investing/091014/basics-forming-limited-liability-company-llc.asp
[12]
https://www.bpm.com/insights/multiple-llc-pros-and-cons/