James R. Balmforth: Can A Limited Liability Company Be A Qualified International Buyer?

A limited liability company (LLC) is a corporate structure in the United States whereby the owners are not personally liable for the company’s debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship. While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of partnerships.

A limited liability company (LLC) is a hybrid legal entity having certain characteristics of both a corporation and a partnership or sole proprietorship (depending on how many owners there are). An LLC is a type of unincorporated association distinct from a corporation. The primary characteristic an LLC shares with a corporation is limited liability, and the primary characteristic it shares with a partnership is the availability of pass-through income taxation. As a business entity, an LLC is often more flexible than a corporation and may be well-suited for companies with a single owner. Although LLCs and corporations both possess some analogous features, the basic terminology commonly associated with each type of legal entity, at least within the United States, is sometimes different. When an LLC is formed, it is said to be organized, not incorporated or chartered, and its founding document is likewise known as its articles of organization, instead of its articles of incorporation or its corporate charter. Internal operations of an LLC are further governed by its operating agreement, rather than its bylaws. The owner of beneficial rights in an LLC is known as a member, rather than a shareholder. Additionally, ownership in an LLC is represented by a membership interest or an LLC interest (sometimes measured in membership units or just units and at other times simply stated only as percentages), rather than represented by shares of stock or just shares (with ownership measured by the number of shares held by each shareholder). Similarly, when issued in physical rather than electronic form, a document evidencing ownership rights in an LLC is called a membership certificate rather than a stock certificate. In the absence of express statutory guidance, most American courts have held that LLC members are subject to the same common law alter ego piercing theories as corporate shareholders. However, it is more difficult to pierce the LLC veil because LLCs do not have many formalities to maintain. As long as the LLC and the members do not commingle funds, it is difficult to pierce the LLC veil. Membership interests in LLCs and partnership interests are also afforded a significant level of protection through the charging order mechanism. The charging order limits the creditor of a debtor-partner or a debtor-member to the debtor’s share of distributions, without conferring on the creditor any voting or management rights.

Limited liability company members may, in certain circumstances, also incur a personal liability in cases where distributions to members render the LLC insolvent.

What is a QIB?

A qualified institutional buyer (QIB), in United States law and finance, is a purchaser of securities that is deemed financially sophisticated and is legally recognized by securities market regulators to need less protection from issuers than most public investors. Typically, the qualifications for this designation are based on an investor’s total assets under management and specific legal conditions in the country where the fund is located. Rule 144A requires an institution to manage at least $100 million in securities from issuers not affiliated with the institution to be considered a QIB. If the institution is a bank or savings and loans thrift they must have a net worth of at least $25 million. If the institution is a registered dealer acting for its own account it must in the aggregate own and invest on a discretionary basis at least $10 million of securities of issuers not affiliated with the dealer. Certain private placements of stocks and bonds are made available only to qualified institutional buyers to limit regulatory restrictions and public filing requirements.

Understanding Limited Liability Companies (LLCs)

Limited liability companies (LLCs) are a business structure that is allowed under state statutes. The regulations surrounding LLCs vary from state to state. LLC owners are generally called members. Many states don’t restrict ownership, meaning anyone can be a member including individuals, corporations, foreigners and foreign entities, and even other LLCs. Some entities, though, cannot form LLCs, including banks and insurance companies. An LLC is a more formal partnership arrangement that requires articles of organization to be filed with the state. An LLC is much easier to set up than a corporation and provides more flexibility and protection. LLCs don’t pay taxes. Instead, profits and losses are listed on the personal tax returns of the owner(s). If fraud is detected or if a company hasn’t met legal and reporting requirements, creditors may be able to go after the members. Members’ wages are deemed operating expenses and are deducted from the company’s profits.

Some Advantages

• Choice of tax regime. An LLC can elect to be taxed as a sole proprietor, partnership, S corporation or C corporation (as long as they would otherwise qualify for such tax treatment), providing for a great deal of flexibility.

• A limited liability company with multiple members that elects to be taxed as partnership may specially allocate the members’ distributive share of income, gain, loss, deduction, or credit via the company operating agreement on a basis other than the ownership percentage of each member so long as the rules contained in Treasury Regulation (26 CFR) 1.704-1 are met. S corporations may not specially allocate profits, losses and other tax items under US tax law.

• The owners of the LLC, called members, are protected from some or all liability for acts and debts of the LLC, depending on state shield laws.

• In the United States, an S corporation has a limited number of stockholders, and all of them must be U.S. tax residents; an LLC may have an unlimited number of members, and there is no citizenship restriction.

• Much less administrative paperwork and record-keeping than a corporation.

• Pass-through taxation (i.e., no double taxation), unless the LLC elects to be taxed as a C corporation.

• Using default tax classification, profits are taxed personally at the member level, not at the LLC level.

• LLCs in most states are treated as entities separate from their members. However, in some jurisdictions such as Connecticut, case law has determined that owners were not required to plead facts sufficient to pierce the corporate veil and LLC members can be personally liable for operation of the LLC)

• LLCs in some states can be set up with just one natural person involved.

• Less risk of being “stolen” by fire-sale acquisitions (more protection against hungry investors).

• For some business ventures, such as real estate investment, each property can be owned by a separate LLC, thereby shielding the owners and their other properties from cross-liability.

• Flexible membership: Members of an LLC may include individuals, partnerships, trusts, estates, organizations, or other business entities, and most states do not limit the type or number of members.

Some of the Disadvantages

Although there is no statutory requirement for an operating agreement in most jurisdictions, members of a multiple member LLC who operate without one may encounter problems. Unlike state laws regarding stock corporations, which are very well developed and provide for a variety of governance and protective provisions for the corporation and its shareholders, most states do not dictate detailed governance and protective provisions for the members of a limited liability company. In the absence of such statutory provisions, members of an LLC must establish governance and protective provisions pursuant to an operating agreement or similar governing document.

• It may be more difficult to raise financial capital for an LLC as investors may be more comfortable investing funds in the better-understood corporate form with a view toward an eventual IPO. One possible solution may be to form a new corporation and merge into it, dissolving the LLC and converting into a corporation.

• Many jurisdictions—including Alabama, California, Kentucky, New York, Pennsylvania, Tennessee, and Texas—levy a franchise tax or capital values tax on LLCs. In essence, this franchise or business privilege tax is the fee the LLC pays the state for the benefit of limited liability. The franchise tax can be an amount based on revenue, an amount based on profits, or an amount based on the number of owners or the amount of capital employed in the state, or some combination of those factors, or simply a flat fee, as in Delaware.

• Renewal fees may also be higher. Maryland, for example, charges a stock or nonstock corporation $120 for the initial charter, and $100 for an LLC. The fee for filing the annual report the following year is $300 for stock-corporations and LLCs. The fee is zero for non-stock corporations. In addition, certain states, such as New York, impose a publication requirement upon formation of the LLC which requires that the members of the LLC publish a notice in newspapers in the geographic region that the LLC will be located that it is being formed. For LLCs located in major metropolitan areas (e.g., New York City), the cost of publication can be significant.

• The management structure of an LLC may not be clearly stated. Unlike corporations, they are not required to have a board of directors or officers. (This could also be seen as an advantage to some.)

• Taxing jurisdictions outside the US are likely to treat a US LLC as a corporation, regardless of its treatment for US tax purposes—for example a US LLC doing business outside the US or as a resident of a foreign jurisdiction. This is very likely where the country (such as Canada) does not recognize LLCs as an authorized form of business entity in that country.

• The principals of LLCs use many different titles—e.g., member, manager, managing member, managing director, chief executive officer, president, and partner. As such, it can be difficult to determine who actually has the authority to enter into a contract on the LLC’s behalf.

Forming an LLC

Although the requirements for LLCs may vary by state, there are generally some commonalities across the board. The very first thing owners or members must do is to choose a name. Once that’s done, the articles of organization must be documented and filed with the state. These articles establish the rights, powers, duties, liabilities, and other obligations of each member of the LLC. Other information included on the documents includes the name and addresses of the LLC’s members, the name of the LLC’s registered agent, and the business’ statement of purpose. The articles of organization must be accompanied by a fee paid directly to the state. Paperwork and additional fees must also be submitted at the federal level to obtain an employer identification number (EIN).

• Limited liability companies are corporate structures in the United States where owners are not personally liable for the company’s debts or liabilities.

• Regulations surrounding LLCs vary from state to state.
• Any entity can form an LLC including individuals and corporations; however, banks and insurance companies cannot.
• LLCs do not pay taxes—their profits and losses are passed through to members, who claim them on their tax returns.
Requirements to qualify as a QIB
The U.S. Securities and Exchange Commission (SEC) requires that an entity meet one of the following requirements to qualify as a QIB:
• Any of the following entities, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity:
• An insurance company
• An investment company registered under the Investment Company Act of 1940
• A Small Business Investment Company licensed by the US Small Business Administration under the Small Business Investment Act of 1958
• A plan established and maintained by a state, its political subdivisions, or state agency, for the benefit of its employees
• An employee benefit plan falling under the Employee Retirement Income Security Act of 1974
• A trust fund whose trustee is a bank or trust company and whose participants are exclusively plans established for the benefit of state employees or employee benefit plans, except trust funds that include as participant’s individual retirement accounts or H.R. 10 plans
• A business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940.
• A 501(c)(3) charitable organization, corporation (other than a bank or a savings and loan association), partnership, or Massachusetts or similar business trust; and
• An investment adviser registered under the Investment Advisers Act of 1940.

• Any registered dealer, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $10 million of securities of issuers that are not affiliated with the dealer.
• Any registered dealer acting in a riskless principal transaction on behalf of a qualified institutional buyer.
• Any investment company registered under the Investment Company Act, acting for its own account or for the accounts of other QIBs, that is part of a family of investment companies which own in the aggregate at least $100 million in securities of issuers, other than issuers that are affiliated with the investment company or are part of such family of investment companies.
• Any entity, all of the equity owners of which are QIBs, acting for its own account or the accounts of other QIBs.
• Any bank or any savings and loan association or other institution, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with it and that has an audited net worth of at least $25 million as demonstrated in its latest annual financial statements, as of a date not more than 16 months preceding the date of sale under Rule 144A in the case of a US bank or savings and loan association, and not more than 18 months preceding the date of sale for a foreign bank or savings and loan association or equivalent institution.

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