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In 1977, when the state of Wyoming first passed legislation allowing a new type of company called a Limited Liability Company (LLC), hardly anyone noticed. Today, over two-thirds of all new companies formed are LLCs.
Before the establishment of the LLC, the combination of limited liability and pass-through tax treatment could only be acquired through a Sub-Chapter S Corporation, which imposed severe limitations on the number of shareholders and did not allow anyone but individual taxpayers in the United States to become business owners. General corporations were eligible for the liability protection but not pass-through tax treatment, and partnerships were permitted pass-through tax treatment but not limited liability. The creation of the LLC allowed for a hybrid entity in which both pass-through tax treatment and limited liability could co-exist, legally, for the first time.
The IRS largely ignored the entity for almost 11 years, until the state of Delaware revolutionized the legal world by drafting and approving a new form of company legislation that combined asset protection and limitation on member's personal liability with IRS-approved pass-through tax treatment. That groundbreaking company legislation is now known as the modern Delaware LLC Act.
In 1993, after subsequent IRS approvals, the Delaware LLC Act became the gold standard among LLC laws, largely because the Act allows business owners to determine the structure and rules that govern the members of their LLCs in a contract they craft and customize.
Delaware Limited Liability Companies are extremely flexible and offer a custom internal company agreement, now more commonly referred to as an Operating Agreement, which both establishes and governs the LLC. Since business owners have freedom of contract to draft their own Operating Agreements any way they see fit, the result is business owners creating company structures that fit their unique situations perfectly.
Consider these two different situations: Business A drafts an Operating Agreement that focuses on holding real estate assets while protecting the owners of the LLC from any potential bankruptcy or creditors resulting from the LLC's real estate holdings. Business B, a family business, is run by several family members; their LLC's Operating Agreement assigns the rights and responsibilities of the LLC to particular family members, and also outlines specific rules of succession for the family business. Both scenarios are valid uses of an LLC Operating Agreement, and both illustrate the flexibility and necessity of owners drafting their own Operating Agreements.
This year, more than two-thirds of all new companies formed in Delaware, often called the Home of the Corporation, will be Delaware Limited Liability Companies.Form a Delaware LLC Now!
The HBS Blog offers insight on Delaware corporations and LLCs as well as information about entrepreneurship, startups and general business topics.
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