Any entity that can issue equity or debt, and does not include a bad actor, may use Regulation D private placements to sell securities.
Choosing which type of entity to serve as the issuer for the securities depends on a variety of factors, including: (a) whether the operating entity is the entity issuing the securities or is an affiliate, (b) whether the issuer intends to have multiple classes of securities, (c) whether any profits or losses will be passed through to investors, (d) whether the issuer desires to have multiple offerings, and many other possible factors. Based on these factors, the issuer’s principals will determine what type of entity to use to provide the desired structure. One type of entity that is becoming more common, especially for serial issuers, is the Series LLC.
What is a Series LLC?
A Series LLC (SLLC) is a special type of entity in some states that provides liability protection across multiple series each of which, at least theoretically, is protected from liabilities arising from actions of the other series. What this normally looks like is a single Master LLC with separate divisions for each series.
What are the benefits?
There are many benefits to using a SLLC if you are planning to conduct multiple offerings close together or even simultaneously. These benefits include:
- Limited registration cost. In many states that allow SLLCs, only the Master LLC is required to be registered, thus cutting down registration costs. While this may not be a large concern if you are registering a handful of LLCs, as the number of LLCs that need to be registered increases, even a $300 registration fee becomes significant.
- Separation of assets. This may be one of the more common reasons for the use of SLLCs. Say you want to pool funds to purchase a specific piece of real estate or security as part of a larger investment strategy, but you want to limit the benefits and liabilities associated with that asset to just one set of investors. Using a SLLC can create a daughter LLC, raise capital from investors interested in that specific asset, and then purchase/invest in it. This allows investors to pick and choose what specific assets they want to be invested in verses being part of a fund that holds a variety of assets.
- Separate EIN. This may seem like an odd one, but in our experience SLLCs often allow the daughter LLCs to each have their own Entity Identification Number. This is important in conducting a private placement offering as many banks require a separate EIN to open an escrow account. While this does not differentiate a SLLC from opening multiple LLCs, it does solve a problem that we occasionally see where an individual LLC or partnership attempts to conduct multiple offerings at the same time.
- Separate liability for each sub-LLC. One of the defining characteristics of the SLLC is that each sub-LLC is protected from liability for the actions or losses of another sub-LLC. This allows investors to avoid potential liability and loss that might affect an asset in a different sub-LLC. It also allows investors to allocate their risk more individually.
What are the drawbacks?
Along with several benefits, there are also a few drawbacks to consider with the SLLC as an entity.
- Lack of diversity. One of the potential issues with SLLCs and how they are normally used, is that the investors, and the entity itself, usually lack the protection of a diversification of assets. Diversification of investments protects investors from suffering the catastrophic losses that can occur when an investor is over concentrated in a specific investment or industry. If an investor is investing in a SLLC as a part of a broader investment strategy that is diversified in assets and industries, then it may be a smart investment decision. In the absence of a diverse portfolio, however, investing in SLLCs can be dangerous.
- State limitations. Only certain states allow SLLCs to be formed. So, an individual considering raising capital should be sure to consult with an attorney if he intends to use SLLCs to ensure the entity is properly organized in a state that allows SLLCs.
Series LLCs are an entity form that is gaining popularity in the private placement environment, especially in the area of serial issuers. While there are benefits to the use of a SLLC, this entity type is not a fit for all potential issuers. Potential issuers should carefully consider both the benefits and drawbacks with an attorney before choosing to use a SLLC to raise funds.
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Disclaimer: WealthForge provides this information to our clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.