Should I use LegalZoom to help start my business?
Lawyers love to complain about online legal services, such as LegalZoom. I'm routinely asked why someone shouldn't just start their company on LegalZoom, and why even involve an attorney in the first place. From an outward perspective, an attorney and LegalZoom do the exact same thing: fill out a form and mail it off to the Secretary of State. Pretty simple, right?
So, should you use LegalZoom to help start your business?
I'm not going to lie to you, LegalZoom might actually be an effective way to form your company. In about 2% of circumstances. However, if you're not in the rare subset of situations where LegalZoom might help you, it might actually result in some disastrous consequences.
LegalZoom and its ilk are really only good for single-owner companies with no employees who do a small amount of business and who don't trigger any compliance requirements. As a practical matter, this weeds out about 80% of businesses.
If you need any legal advice, at all, LegalZoom is a bad option. LegalZoom is not a law firm. Not only do they have a policy of not providing legal advice, but if they tried to give you advice, they could wind up in jail. That means that they are only going to give you the most basic information, and nothing that would even potentially border on legal advice. This weeds out the last 20% or so of businesses.
That means that if you have no partners in your business, no employees, not even the chance of having another partner or investor in the future, do not trigger any regulatory requirements, do not need legal advice, do not need tax advice, or just simply don't know how to fill out the forms, LegalZoom can be a bad option for you.
That said, you might still think that I am trying scare you into hiring someone like me for the sole purpose of bolstering my bottom line, so, let's talk specifics.
The devil is always in the details
A large percentage of my business is setting up, restructuring, tearing down, and generally maintaining limited liability companies and corporations. My work spans from broad questions, such as whether to choose between a LLC or corporation, down to detailed items, such as selecting a trademark-compliant business name and structuring the business aspects to maximize tax benefits.
In my experience, I've learned that seemingly benign clauses in a LLC Operating Agreement (the controlling document of a LLC, now often called the Limited Liability Company Agreement) can have enormous unintended consequences.
As a practical matter, the two main problems that usually pop up in a LLC are:
- Distributions of income or assets and
- Leaving or dissolving the LLC.
It shouldn't be any surprise, but LegalZoom does not have much protection or guidance on either of these issues.
If you ever speak to someone that has gone through a business divorce, they will usually tell you that they brought a lot more to the table and the other partner. Pretty much every single time I speak to someone who wants a business divorce, they tell me that how they work twice as hard as the other partner and that what they bring to the table is significantly more valuable than what the other partner brings.
With the LegalZoom operating agreement, this is meaningless. LegalZoom's standard Limited Liability Company Agreement states that any distribution must be distributed "pro rata" based upon a member's ownership in the company, regardless of what they actually do for the company.
What this means is that, once two partners sign a LLC agreement from LegalZoom, one partner can simply stop showing up to work, and would still be entitled to 50% of the net profits and assets of the company, without doing any work.
This problem is only compounded in LegalZoom LLCs because there is a problem...
One of the most surprising aspects of LegalZoom's standard operating agreement is its provision for leaving a LLC. There isn't one.
LLCs fall under partnership law. That means that partners are only partners as long as they want to be partners. As soon as one person in a partnership wants out of the partnership, the partnership dissolves as a matter of course. If there are more than two partners, the remaining partners can choose to continue on with the business once the departing partner's share has been paid.
Under LegalZoom's standard LLC agreement, a partner in the company cannot leave unless (1) he or she transfers their ownership or (2) if the other partners unanimously agree. However, if your partner is a deadbeat that hasn't shown up to work in 3 months and you're his new cash cow, there isn't a soul on this planet that will buy your interest (even if the other partner approved it, which is also required). In fact, if you try to resign, you could be found liable for what is called "wrongful dissociation," which is the equivalent of the company you founded suing you for breach of contract.
Instead of being entitled to your share of the LLC's assets, you could now end up owing the company money because you wanted to leave.
The biggest problem
While these are a couple of the high points, and some of the issues that I deal with most often, there are 100 other problems that can arise in a LLC, and only about a dozen are actually addressed in LegalZoom's standard operating agreement.
In spite of it all, the biggest problem that LegalZoom's LLC agreement creates is this: it doesn't actually address how partners, investors, owners, officers, or really anyone involved with the LLC actually intends to work within or with the LLC.
It is a standard agreement, that is it. It is designed to appeal to the lowest common denominator, which simply doesn't cover a lot.
In the last five years, I have probably set up over a hundred different LLCs. I've personally handled dozens of disputes, and litigated many. In that time, I've never seen an LLC that exactly resembled another one.
Business partnerships bear a lot of similarities to romantic relationships like marriages. If you used a standard operating agreement in a marriage, you wouldn't be happy for long. The law is notoriously slow-moving, so a standard marriage operating agreement would probably still have a male as a primary income earner and a female as solely responsible for items around the house. This is what you would expect from a standard agreement, based on historic understandings, that is drafted to the lowest common denominator.
Using a standard operating agreement in a LLC has much the same results. You will probably end up signing up for something that you did not know that you are signing.
If you are a single business owner who is trying to start-up a side business, and you aren't worried about any legal issues such as licensing, or tax issues, or bringing on another investor, or taking on employees, or making this a full-time job, going to LegalZoom might be a good solution for you. However, if you don't check each and every one of those boxes, or if you just need legal advice, LegalZoom is going to be a bad solution.
A good business lawyer will charge anywhere between about $500 and $1000, plus filing fees, to set up a LLC, which usually includes an Operating Agreement or Limited Liability Company Agreement. This almost always includes a more tailored agreement, that actually conforms to your situation, than you would get through LegalZoom.
Admittedly, this might be three or four times as much as LegalZoom will charge you for the same service. However, I can also tell you that a good business lawyer will usually charge several thousands of dollars just for a retainer to litigate an issue that could have been handled in an hour or two in the initial start-up phases.
Chances are, you should at least speak with an attorney about setting up your LLC instead of LegalZoom. Consider it a prenup in advance of a very-likely business divorce. A few hundred dollars today could save you thousands a year or so away.
If you're interested in setting up an LLC to start your business, we can help. Give us a call at 205-545-7278 or shoot us an email at firstname.lastname@example.org!