Series LLCs
Series LLCs are a relatively new type of entity that more and more states are embracing. Still, many experienced businesspeople are unfamiliar with series LLCs.
Below, I break down the concept of a series LLC, their benefits, and some potential issues.
What Is a Series LLC?
To understand what a series LLC is, think of a standard org chart with a parent entity and multiple subsidiaries. The parent and its subsidiaries are each legally distinct entities that can sue or be sued in their own names, own their own assets, and so on. A series LLC collapses the org chart from multiple entities to just one LLC with different cells (called “series”). Each series is part of the same entity but has the features of a distinct entity. But the owners get to avoid the hassle of forming dozens of companies, paying filing fees, and so on.
Delaware was the first state to allow series LLCs in 1996. Since then, a number of other states and U.S. territories authorized them, though the majority of states still do not. This could be a problem for reasons discussed below.
As with normal LLCs, corporations, partnerships, or other entities, states tend to have very different legal and operational requirements for series LLCs. Some states, for example, may require separate filings for individual series, where others may not. Some states, like California, do not allow formation of series LLCs, but will recognize series LLCs doing business within the state so long as they register with the California Secretary of State (this could require multiple registrations if multiple series “do business” in the Golden State).
The Problems with Series LLCs
Series LLCs come with a lot of baggage. First, they are very different from the “normal” entity types, and so can be difficult to manage for people unfamiliar with them. While series LLC laws aim for governance similar to traditional LLCs, things can become complicated when it comes to series with different functions and ownership. So, it’s important to consider whether a series LLC is better for an individual business than a traditional parent-subsidiary or affiliated entity structure.
Second, states do wildly different things when it comes to recognizing foreign (i.e., other state) series LLCs. For example, Arizona law states:
A foreign limited liability company, its members and managers and its foreign series, if any, have no greater rights and privileges than a domestic limited liability company and its members and managers with respect to transactions in this state and relationships with persons in this state that are not managers or members. A foreign series is liable for the debts, obligations, or other liabilities of the designating foreign company and of any other foreign series of that designating foreign company, arising out of transactions in this state or relationships with persons in this state and a designating foreign company is liable for such debts, obligations, or other liabilities of each foreign series of that designating foreign company.
In plain English, say a cell of a Delaware series LLC breaches a contract with an Arizona company and gets sued in Arizona – the assets of all cells of the series LLC would be on the table, not just the assets of the breaching cell. This completely undermines the point of a series LLC and actually would do much more harm than the other, traditional models discussed above where assets of affiliated entities would not be reached by the creditor absent veil piercing (which itself can be hard to prove).
Third, tax law is not necessarily a picture of clarity. The IRS has no official series LLC regulations, but did previously propose regulations that would treat each series as a separate entity. States may simply ignore the distinction between series, and tax the entire series LLC as a single entity.
Fourth, individual cells within a series LLC are not recognized as a “person” under the Bankruptcy Code. This is important because –as with states like Arizona — it’s certainly possible that bankruptcy proceedings for a specific cell could spill over into others.
The Benefits of Series LLCs
Now that we addressed some of the problems with series LLCs, let’s look at some of the benefits. First, series LLCs offer many of the same protections you’d see with the standard parent-subsidiary model. For example, real estate could be held by individual series, where in a parent-subsidiary model, it would be held by individual subsidiaries. This could save on filing fees, regulatory filings, and other red tape associated with more traditional entity models.
Second, series LLCs lend themselves well to fractionalization of assets. Take, for example, the company Masterworks, which allows regular folks like you and me to invest in specific pieces of art. What Masterworks appears to do is to form series LLCs, with individual cells that own individual pieces of art. It then appears to sell membership interests in those series (as opposed to ownership directly of the art).
Companies that offer these fractional interests often leverage Regulation A, a regulation I extensively outlined previously. This regulation harmonizes well with the structure of Series LLCs, opening a promising avenue for substantial growth in the realm of fractional ownership in the foreseeable future.
The Role of Series LLCs
As relatively recent additions to the array of legal business structures, series LLCs present a novel opportunity for innovation. Yet, for many traditional businesses operating across multiple states, the transition to series LLCs may still involve overcoming certain hurdles before they are the best option. Despite their drawbacks, series LLCs can provide significant benefits to certain business models, such as fractionalized asset sellers.
