Dec 30, 2020
Series LLCs and Blockchain: Circling the Wagons
The Series LLC as an Optimal Small Business Structure for Applying Smart Contract Automation
Over the last few years, there have been attempts at creating autonomous groups based on smart contract protocols, but these have met with varying levels success as verified legal entities. These types of organizations, depending on their basis, have met with problems related to scalability and personal liability. For the latter, the Decentralized Autonomous Organization (The DAO) was able to easily source venture capital and establish new projects via its internal protocol and governance structure, but ran afoul of the SEC and could not prospectively limit the liability of its members. As for the former, the Limited Liability Autonomous Organization (The LAO) has merged the idea of automated governance and limited liability entities by treating the base Ethereum governance protocol as an operating agreement, rather than a simple contract, but is limited in its scope due to its experimental and self-limiting nature. I believe that a novel form of the LLC available in several states, known as the Series LLC, presents a unique opportunity to incorporate the scaling capabilities of the DAO with the liability limitation properties of the LAO.
The Series LLC is a perplexing business structure that has not really caught on outside of real estate developers and novel startups, mainly because banks don’t know how to treat it and its benefits are only apparent when separating large assets with separate revenue streams such as real property. Additionally, the cost of setting up another standalone LLC appears to be substantially similar and eliminates many of the concerns about how it would be treated by regulators and the laws of states that don’t recognize Series LLCs. For these reasons, many in the law have kept the Series LLC at arms-length due to ultimate questions about the effectiveness of its liability-shielding properties. However, I believe that given a forward-thinking use case, this business structure may be adopted by many other states given its unique properties when used in conjunction with blockchain systems.
Present Use: Practical Considerations
A Series LLC differs from a normal LLC in that it allows for the creation of multiple subsidiary entities (each of which are known as a “Series”) through internal governance of the Parent LLC. The Parent LLC must then provide notice to the Secretary of State’s office regarding their creation and the limitation of the Series Members’ liability as separate from the Parent LLC. For example, in the Iowa Act, notice is effective if noted in the Certificate of Organization or if the Certificate filed with the Secretary of State is amended to include information about the Series. A Series must maintain separate books, bank accounts, management, and generally must be treated as a distinct entity from the Parent LLC. This must also be noted in the operating agreement of the Parent LLC. If these requirements are met,the Series is now treated as a standalone company under Iowa law.
At present, the best use case for Series LLCs is that of a domestic asset holding company, with multiple Series’ for for assets that are both valuable and subject to genuine liability, such as real estate. Real estate is the prototypical example because of its singular nature, ease of separation, and income generating properties. Keeping different properties in separate Series would maximize both the utility of liability-shielding properties and minimize the risk of veil-piercing. This allows the members of the Parent LLC to maintain effective control over the asset while “circling the wagons” with their different assets, maintaining protection for the Parent LLC even if one asset is attacked.
Potential Use Case: Smart Contract Integration
In my opinion, the optimal use case for Series LLCs is as a holding company utilizing automated governance made possible by blockchain-based smart contracts. This will allow LLCs to become even stronger than they are now due to additional liability shields and an increased ability to separate and fund new ventures under the umbrella of a common enterprise.
At present, we are witnessing the proliferation of the technology that will make this possible, simplifying corporate governance and management of assets and income through experiments such as the DAO and legally-sanctioned innovations such as The LAO. The DAO, though inherently flawed, was a prototype for corporate forms of the future that utilize digital protocols for voting and company-wide initiatives for investment and strategic growth. The LAO, a digital framework created by the lawyers at OpenLaw, took much of what was innovative about the DAO and combined it with the liability-shielding properties of a Limited Liability Company. The success of the OpenLaw initiative is promising, but appears limited in scale when compared with the highly liquid functionality of the DAO.
A large part of corporate law is a factor of contract principles that govern the internal conduct of a company. This principle was the entire basis of the DAO, but ultimately wasn’t enough to give it legitimacy in the legal world. When referring to “smart contracts” as a concept, internal contract principles are implicated as well as contracts between the company and external parties, including the states and countries where business is conducted.
As the technology for automated governance proliferates, the Series LLC may be adopted by forward-thinking lawyers and prospective LLC Members for its flexibility and efficiency in accomplishing needed internal and external agreements through highly secure smart contract protocols. What is also appealing is the Series LLC’s potential to give regular people the ability to program secure agreements for high-growth businesses, and maintain growth through strong liability-limiting properties. Paper-based entities may be with us for quite some time, but the promise of a better way of doing business may present a worthy competitor.
