Ask the attorney: The pros and cons of single-member LLCs

(Editor’s note: “Ask the Attorney” is a VentureBeat feature allowing start-up owners to get answers to their legal questions. Submit yours in the comments below and look for answers in the coming weeks. Author Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a boutique corporate law firm specializing in the representation of entrepreneurs.)
Question:  I plan on forming a single-member limited liability company (LLC) in California as an umbrella for a number of my different internet-related projects.  One particular project will involve subscription revenue from businesses around the country.  I have heard that some states may not recognize single-member LLC’s.  Are these types of Internet businesses suitable for a single-member LLC?  Any other thoughts on single-member LLC’s are appreciated.  Thanks!
Answer:  Any entity (whether it be a corporation, a limited partnership or an LLC) has its advantages and disadvantages.  A single-member LLC is a relatively new animal and is recognized in all 50 states and the District of Columbia.  In theory, it has two significant advantages – in reality, though, probably only one.
First, like all LLC’s, a single-member LLC is designed to protect against personal liability.  Accordingly, it should arguably be treated as a separate “person” for legal purposes, and thus the sole member/equity holder should be shielded from any liabilities of the LLC, including debts and lawsuits.
Second, a single-member LLC will be treated as a “disregarded entity” for federal income tax purposes (unless it formally elects to be treated as a corporation), and thus its profit or loss will be reported on an individual member’s Schedule C as if it were a sole proprietorship.  This will save the member time and money in connection with the preparation of income tax returns, since the separate LLC entity need not file returns.
The disadvantage of a single-member LLC is the risk that, unlike multiple-member LLC’s, it will not protect against personal liability in the event of a lawsuit or other claim.  Indeed, certain courts have “pierced the veil” of a single-member LLC and have held that it is not a separate entity and thus may not be used to protect the assets of the LLC from the creditors of the member.
To avoid the “piercing of the veil” issue, many corporate practitioners advise their clients to do two things: (i) create sufficient legal documentation (including a single-member operating agreement and Board of Manager resolutions, etc.) to reflect that the single-member LLC is indeed a separate entity and has been treated as such; and (ii) if there is significant liability exposure, issue a small equity interest (e.g., 2%) to a close relative – i.e., create a multiple-member LLC — in which case, it will not be a “disregarded entity” for tax purposes.
(Please note that I am not a tax lawyer – and this should not be construed as tax-related advice in any respect..)
Looking at your particular situation, the good news is that Internet-related projects do not likely have significant liability exposure (as opposed to a manufacturing project or the purchase of real estate).  On the other hand, as I have previously discussed, if you will be seeking venture capital funding, an LLC (single-member or otherwise) may not be the best choice.
The bottom line is that you need to sit down with a reasonably-priced lawyer and accountant and discuss the foregoing issues and determine what works best for you, based on your business objectives and risk tolerance.
Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  The author and his firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.
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