In 1997, Delaware passed the world’s first Series LLC law. In doing so, the Delaware LLC Act did something revolutionary. It empowered business owners to establish an unlimited number of internal asset chambers, now called “protected series” with just one state filing.
The Series LLC represents the cutting-edge in asset protection vehicles. Protected series allow business owners to separate the assets and liabilities without the need to form multiple business entities.
The creditors of one protected series are prevented from foreclosing on any other business assets within the Series LLC. This asset protection strategy is called “ring-fencing”. While a barn-like roof exists over the entire entity, the assets can be roped off in separate paddocks. This keeps creditors of one protected series from attaching assets of other protected series.
Series LLCs are being used to support a wide range of innovative businesses. Oil field investments, pharmaceuticals, tax sale bidding, and captive insurance companies all use the Series LLC to achieve ironclad liability protection. Any business holding low-risk assets can use a Series LLC to achieve internal liability protection without the burden of forming multiple entities.
Serial entrepreneurs benefit from the freedom and flexibility provided by the Series LLC. Series LLCs allow multiple ideas to be incubated with just one business entity. Successful businesses in a Series LLC can even be spun off into separate LLCs.
The creditors of one protected series are prevented from foreclosing on any other business assets within the Series LLC.
The Series LLC started as special interest legislation for the mutual fund industry, allowing fund managers to enjoy the protection of having multiple entities with only one filing fee. The Series LLC remains popular in the regulated finance industry. Investment companies use protected series to segregate different funds and classes of investments, isolating financial risk within a family of funds.
Real estate investors have taken advantage of the Series LLC structure. By holding each property in a separate titleholder series, the Series LLC can protect each property from the obligations and liabilities of other properties or the LLC in general. This makes the Series LLC an attractive option for those looking to manage a portfolio of properties.
Since its introduction in Delaware, the Series LLC has been adopted by over one third of the United States. With new Series LLC bills being drafted all over the country, the Delaware Series LLC remains the cutting-edge. The state’s business-friendly laws make Delaware the preeminent location for your company’s legal home.
Opting into the Delaware LLC Act allows you to export the “gold standard” Delaware Series LLC law and gain access to the prestigious Delaware Court of Chancery. The benefits of forming in Delaware travel with your business. Delaware law will govern the internal affairs of your company almost wherever you operate.
Opting into the Delaware LLC Act allows you to export the “gold standard” Delaware Series LLC law.
The Delaware Series LLC offers a range of benefits for businesses of all sizes. From effective liability protections to lower startup and annual costs, the Series LLC has a leg up on other traditional legal entities.
Here are the key benefits of forming a Delaware Series LLC:
Internal Firewalls For Liability Protection
The Series LLC uses an asset protection strategy called “ring-fencing”. The assets of each protected series are shielded from the debts, obligations, or liabilities of any other protected series or the general LLC. This means that a hostile creditor cannot foreclose upon the assets of a single protected series in order to settle the debts of another.
The internal firewalls between protected series are super power of the Series LLC. For serial entrepreneurs operating multiple lines of business, this liability protection can prevent one struggling endeavor from sinking the entire enterprise.
Simplicity of One Filing
The Delaware Series LLC allows you to create an unlimited number of protected series with minimal hassle.
Forming a Delaware Series LLC requires only one entity filing. Individual protected series are created simply by amending the Series LLC Operating Agreement. A protected series can be created or dissolved at any time with the approval of all voting members.
Cost Effectiveness
Forming a Series LLC requires only one public filing which means there is only one state filing fee. In Delaware, a Series LLC only makes one annual franchise tax payment no matter how many protected series it establishes.
A Series LLC only needs to appoint one Registered Agent in order to represent all protected series. This means paying just one annual Registered Agent fee for the entire entity
Freedom and Flexibility
The internal affairs of a Series LLC are governed by its private Operating Agreement. This is the internal document detailing the ownership and responsibilities of all members and managers of the company. Changes can be made to the Operating Agreement at any time without requiring any additional filings.
Since the Series LLC Operating Agreement is a private contract, members are able to create unique ownership structures tailored to their business. This can include creating separate classes of owners with different voting rights or specific arrangements for distributions. Changes to a Series LLC’s membership are agreed upon by the LLC’s voting members. They are then implemented through amendments to the Series LLC Operating Agreement.
The Series LLC should be considered by anyone as an alternative to the traditional LLC. Some people may never end up using the protected series feature of the Series LLC. Nevertheless, they have the power of a “blank check” to establish an unlimited number of protected series in the future to the benefit of their business.
Series LLCs are being operated successfully across several industries. They are particularly popular amongst private equity and venture capital firms, captive insurance companies, real estate investment firms, and regulated investment vehicles.
While real estate investment is a common example, this strategy can be applied to other types of low-risk, well insured assets. Serial entrepreneurs with moderate risk-tolerance use Series LLC to separate different business lines during an incubation period. Some businesses may take off while others experience setbacks or even fail.
Here are some ways that Series LLCs are being used:
Investment Companies as Series LLCs
Different types of investment companies, such as mutual funds, have used the Series LLC for decades to segregate different classes of funds.
In an investment company structure, protected series are used as special purpose vehicles to hold individual funds as associated assets. High risk, high-yield investments can be allocated to one protected series, and lower performing long-term investments in another. When an investment reaches maturity, the assets can be liquidated to make distributions to investors. A protected series used to hold the assets can be terminated simply by amending the Series LLC Operating Agreement.
This kind of strategy can keep one particular asset from becoming a contagion that infects every other fund in the family. Investors are afforded limited liability proportionate to their investment in any given fund.
READ MORE: Why A Series LLC Can Be Helpful For An Investment Company.
Local Farms As Series LLCs
A farm is another context where the Series LLC can be used to separate different types of assets.
Each parcel of land owned by the farm can be held in a separate protected series. Protected series can also be created to hold the individual harvests of each crop, such as potatoes, corn, soy beans, wheat, and lima beans.
A second Series LLC can be formed which uses protected series to hold individual pieces of equipment. The tractor, articulating tractor, combine, irrigation equipment, pumps, and trucks can all be held within separate protected series. Another protected series can be created to function as the operating business which hires farm workers and sells crops. Finally, protected series can be used to hold particular silos or customer accounts within a grain elevator.
It is important to note that personal assets of a member should never be mixed into a Series LLC. In this example, the farmer should not hold their farmhouse as an asset of the Series LLC. The farmer may be at risk of losing the farmhouse if a tractor happened to back over a worker.
Personal assets of a member should never be mixed into a Series LLC.
You can put multiple assets into a single LLC, however, this does not provide any internal asset protection. You can think of this practice as putting all of your eggs into one basket. If your business experiences problems, every single egg can crack.
This is the motivation behind asset segregation. Asset segregation prevents one asset with a relatively high liability risk from affecting all of the business assets.
The traditional way to segregate assets is to form an Umbrella LLC. This is also known as a “holding company” structure. Under a holding company, separate LLCs are created for each business or asset. These separate LLCs are often called “subsidiaries”. Each subsidiary names the holding company as its single member. This achieves a consolidation of ownership with an additional layer of liability protection.
How The Series LLC Improves Upon The Holding Company
For many business types, the holding company is not economical if the value of each asset is relatively low. This is where the Series LLC should be considered.
The Series LLC achieves asset separation without multiplying the costs of maintaining separate LLCs. A Series LLC requires paying just one state filing fee, one annual Registered Agent fee, and one annual franchise tax payment to keep the main LLC in Good Standing.
These cost savings add up significantly over time and can enable the business to grow.
At one time the Delaware Series LLC was the only choice. Now, it is still your best option for several reasons:
Delaware’s Business-Friendly Laws.
Legal scholars all over the world consider Delaware’s corporate and LLC laws to be the gold standard. The state legislature regularly reinforces the asset protection shields of Delaware business entities. The courts then thoroughly scrutinize these protections and hold them up.
A prime example of Delaware’s amicable laws is the Business Judgment Rule. The rule protects business managers from lawsuits when making crucial business decisions to prevent them from being second guessed. Oftentimes, general business cycles or “black swan” economic events may make what were originally sound business decisions look like irrational gambles.
Owners looking retrospectively may try to hold managers accountable for unfortunate outcomes. In Delaware, these remedies are very difficult to obtain in court, provided that managers were not self-dealing. Delaware law gives managers the freedom to take the kinds of calculated risks that drive growth and innovation, knowing they are backed by the best liability protections available.
Delaware provides that almost any statutory provision can be modified through private agreement. This is known as Maximum Freedom of Contract. Laws in other states tend to be more prescriptive and look to limit what business owners can do. It is often the case that the weaknesses of a state’s corporate laws are not apparent until there is a problem. At that point, it may be too late.
Delaware has the ability to reduce or eliminate fiduciary duties of managers and controlling members. Delaware also provides the ability to waive the corporate opportunity doctrine. The only backstop to this is the implied covenant of good faith and fair dealing, which may not be waived.
World Renowned Business Courts
Delaware is known by corporate leaders around the world for the expertise of its dedicated equity court for business disputes called the Court of Chancery.
The Court of Chancery provides Delaware entities with a suite of important benefits:
1.) Unmatched Expertise
Backed by over 200 years of history, the Court of Chancery is credited with having written most of the modern U.S. case law on corporate disputes.
Since the Series LLC originated in Delaware, the Court of Chancery has an absolute advantage in regards to legal precedent and processes pertaining to Series LLCs. Any other state with a Series LLC law is inherently late to the game.
2.) Speedy Trials
The Delaware Court of Chancery is known for operational excellence. The Court is able to turn over the trial process from start to finish (including the discovery of evidence and motions) in as little as two months. It is even possible to expedite appeals to the Delaware Supreme Court.
The Court of Chancery conducts trials like an appellate court. Each side is allotted a set amount of time to present their case. There are also no opening or closing arguments in a Chancery Court trial. This allows the Court to resolve disputes with a high level of efficiency.
3.) Fair Judgments
Unlike typical civil or criminal trials, trials in the Court of Chancery are conducted without a jury present. This means that decisions are solely reliant on the expertise of the Court’s Chancellors.
The high volume of cases met by the Court of Chancery paired with Delaware’s fair business laws provide predictable judicial outcomes. The Court’s Chancellors respect the rights provided for business entities and fiduciaries under Delaware law.
Delaware courts have an absolute advantage in regards to legal precedent and processes. Any other state with a Series LLC law is inherently late to the game.
The Court of Chancery treats business owners as adults when entering into agreements. If partners agree to make a contractual bed, they have to sleep in it. Even if the result may appear unfair in retrospect, a company’s internal agreements have primacy in the eyes of the court. This is provided that any agreements provide specific penalties. In other words, the Court enables business owners to conduct their internal affairs how they see fit.
Members’ Names Are Not on Formation Documents
Delaware does not require the names of beneficial owners of an LLC to appear in public filings.
Low Filing Costs
Delaware Series LLCs only pay one franchise tax per year regardless of how many Protected Series are established. Registered Agents in Delaware charge only one fee for a Series LLC.
The registered series would have filing fees, as well as annual costs, associated with each registered series.
Delaware offers low cost filings, business friendly courts, innovative laws, and developed legal precedent for Series LLCs.
The state in which you form your Series LLC will govern the internal affairs of your company. Your company’s state of formation has general jurisdiction to resolve any disputes involving your company. This includes any lawsuits or a falling out between members.
When forming your Series LLC, you have the ability to “forum shop” for the state law you believe will serve your company best.
Since Delaware originally created the Series LLC, many other states have adopted their own Series LLC statutes. Broader adoption has driven increased popularity amongst entrepreneurs and business owners. Several states are now seeing similar volumes in Series LLC formations to Delaware.
Choosing to form a Series LLC in the state in which you happened to be located is a risk that may have unforeseen consequences. Entrepreneurs generally choose to take comfort in forming a Delaware Series LLC knowing that it is considered the best and most reliable option. They avoid the time and hassle of learning about the intricacies and pitfalls of the laws of their home state.
As of August 1, 2019, the State of Delaware allows for the creation of two types of Series LLCs: a “protected series” or a “registered series”.
The term “protected series” refers to the original type of series provided under the Series LLC law. Protected series have the rights and characteristics of legal persons, allowing them to function like separate, mini LLCs. Protected series can be created simply by amending the Series LLC Operating Agreements.
A “registered series” is an evolution of the protected series. Creating a registered series requires making a separate filing with the state. This additional filing makes a registered series a “registered organization” under the Uniform Commercial Code. This designation gives the registered certain rights and powers that a protected series does not have.
A registered series is able to:
1). Obtain A Certificate of Good Standing
A registered series is able to obtain a Certificate of Good Standing from the Secretary of State. A Certificate of Good Standing notifies interested parties that they are engaging with an entity that is legally compliant within their state of formation. A bank may require this certificate in order to open a business account for a registered series.
2.) Access Secured Financing
A registered series is able to file a UCC-1 Financing Statement in order to perfect a security interest in its assets. The UCC-1 allows a lender to provide public notice of their interest in the property listed. It also gives them priority over these assets in the event of a dispute.
3.) Merge With Other Registered Series
Registered series are able to be merged or consolidated with other registered series within a Series LLC.
Creating a registered series incurs additional costs compared to the protected series. Creating each registered series requires paying an associated filing fee. For a Delaware Series LLC, there is an annual of $75 in order to maintain each individual registered series and keep it in Good Standing.
There are no additional costs associated with creating or maintaining individual protected series.
The new amendments allow for a protected series to convert to a registered series, and vice versa.
Converting a protected series to a registered series requires two separate filings:
To convert a registered series to a protected series, only a Certificate of Conversion is required.
Registered series are subject to special naming conditions. Delaware law requires that the name of a registered series must begin with the name of the main LLC. For example, the name for a registered series of Example LLC would be along the lines of “Example LLC Series 1”. Generally, the name of a registered series must be distinguishable from that of any other series or qualified business entity within the state record
Some entrepreneurs may find that a Series LLC is tricky to maintain. Members and managers have to navigate certain provisions and requirements in order to maintain the internal liability shields between each protected series.
Here are some important points to consider when operating a Series LLC:
The IRS has yet to issue an official ruling for how a Series LLC and its protected series will be treated for federal tax purposes. However, recently proposed rulings shed light on the path they could potentially end up taking.
The IRS’s proposed revenue ruling suggested that each Protected Series within a single Series LLC is entitled to make separate tax elections. This means one protected series can elect to be taxed as a partnership while a second elects to be taxed as an S-Corporation, and a third elects to be taxed as a C-Corporation.
It is generally not advised to make separate tax elections for each protected series. The logistical challenges posed by multiple tax elections may outweigh any of the perceived benefits. Your imagination is the limit with the Series LLC, however, some ideas do not lend themselves to ease of management.
The IRS may require an additional partnership tax return (1065) for each protected series, especially if the business owners “mix and match” a multi-member LLC with different percentage ownerships.
While separate Employer Identification Numbers (IRS Tax ID Numbers) are not required by state law, they are necessary to maintain a separate bank account for each Protected Series.
Obtaining separate EINs for each protected series is not much trouble if the Series LLC only establishes a handful of them. The IRS allows a responsible party to obtain only one EIN per day. Therefore, ten EINs would take no less than 10 days to obtain. This is important to consider before you begin conducting business through your Series LLC.
Your imagination is the limit with the Series LLC, however, some ideas do not lend themselves to ease of management.
Avoid Mixing “Hot” and “Cold” Assets
The Series LLC lends itself to any business holding passive, or “cold”, assets. These are assets which do not attract large amounts of liability. Real estate is a prime example of a cold, passive asset.
The opposite is a “hot” asset. These are operational assets which involve a higher level of risk associated with uninsured or underinsured accidents. Construction equipment is a hot asset with the possibility of producing liability through workplace injuries.
It would not be advisable to put a crane in one protected series, a backhoe in a second, and a truck in a third. These types of assets can act as “lightning rods” for attracting liability. Hot assets pose an unwanted challenge to the internal liability shields within a Series LLC. Although you can break up individual assets and place them into their own protected series, the injured person in a non-contractual setting, known as an involuntary creditor, may try to pierce the internal firewalls of the Series LLC.
Separate Series Agreements
Each protected series should have its own separate Operating Agreement detailing management and ownership. Each separate series agreement is an addendum to the company’s main Operating Agreement.
The intent behind setting up a Series LLC is often to protect the personal assets of each member from the liabilities of the business. The reality is that most attacks on an LLC come from the inside, in the form of disputes or business divorces.
The Series LLC Operating Agreement can be thought of as a prenuptial agreement signed during the honeymoon phase of the business. An experienced legal professional can prepare an Operating Agreement that accounts for many unforeseen contingencies. These provisions can provide swift and fair resolutions for various disputes that may come up between members.
Managing Series LLC Members
A Series LLC has the ability to establish an unlimited number of protected series, each with different members and managers.
However, it is not advisable to mix and match members within one Series LLC. There are several reasons why this strategy is not recommended:
Best practice is to list beneficial owners of a Series LLC as members of each protected series. The Separate Series Agreements can divide management responsibilities of each member as they pertain to a particular protected series. This strategy provides a delegation of responsibilities with a consolidation of ownership.
Record Keeping Requirements
Most Series LLC statutes include stern recording-keeping requirements. Each protected series must maintain separate records to avoid commingling assets. These requirements are presented as conditions that must be met in order to maintain the limited liability shields of each protected series.
Since members of a Series LLC may wear many hats within the organization, it is important to note which protected series is engaging in which transactions. All contracts involving protected series should be specific in detailing this information. Members should keep financial records for each protected series at arms length and be diligent to avoid commingling assets across different protected series.
Each protected series may file a DBA to provide a clear public notice of its existence as a business. Since the protected series is established through the Operating Agreement, having a notarized and official document from the New Castle County, Delaware Superior Court Prothonotary gives transacting parties, such as a bank, the confidence that the series actually exists. The DBA is a relatively low cost filing. There is no annual fee to maintain a DBA.
There are lingering questions regarding how the IRS officially treats the Series LLC for federal tax purposes.
Here are some important points when considering the potential tax implications of a Series LLC:
Your imagination is the limit with the Series LLC, however, some ideas do not lend themselves to ease of management.
A few words about the infancy of the Series LLC. Delaware is preferable because in many senses, it is the most experienced state with the best laws. The earth is moving around beneath our feet and there is a lot of activity going on regarding the Series LLC, even in the state of Delaware.
Still there are uncertainties that will play out over time.
In spite of these open questions, well more than 100,000 Series LLCs have been filed in Delaware and a handful of other states that have the legislation. They are being used across the United States and many parts of the world for very sophisticated transactions.
The law is evolving and improving rapidly making their adoption even more accelerated. The important consideration is to use the Series LLC wisely in terms of the type and value of assets. Then it is important to have a good Operating Agreement and sub-agreements with carefully selected members.
Finally, it is important to maintain the records and contracts as though running separate businesses at arm’s length.
