You’ve finished your business plan, and now the fun begins where you can actually start putting your ideas into motion and start your company. You know that you should form a legal entity to protect your assets, but you are probably unsure what kind. You’ve probably heard a Limited Liability Company (LLC) is the fastest and easiest to set up, but you’re still probably wondering if an LLC is actually the right choice for your business. The following is meant to explain some of the advantages and disadvantages of a limited liability company (LLC), along with the major issues to consider when deciding whether to form an LLC for your business.
General Information About LLCs
Among the various types of business entities, some offer high protection against liability while some offer none at all. LLCs offer a middle ground that protects owners from personal liability, while providing the flexibility of running your business without the corporate “red tape.” See this article for more info on the difference between an LLC and a C-Corp.
LLCs have the same legal protections as corporations, which are the most guarded against personal liability, but escape the issues of double-taxation that come with incorporation. Owners of an LLC, called “members,” are taxed as sole proprietors, meaning that the business income passes through to the members’ personal income taxes. It is important to remember that the laws surrounding LLCs differ in each state. Complying with all the different laws and regulations of each state can be overwhelming. More importantly, you need to be aware that non-compliance with the laws and regulations surrounding LLCs can expose you, your family, and your business to certain risks. This is why hiring an attorney is so important when deciding how and where to form your company. It is also a good idea to learn as much as possible and get informed before you begin. So consider the following advantages and disadvantages of a limited liability company.
Advantages of a Limited Liability Company
Limited liability: As the name implies, members’ liabilities for the debts and obligations of the LLC are limited to their own investment. This is one of the key advantages of a limited liability company. In other words, if your company gets sued, your personal assets, like bank accounts and real estate, are protected. At most, you can only lose the money you put into the business, and nothing else.
Keep in mind that this protection is not all-encompassing. Members can still be held liable for criminal behavior or if they neglect to follow certain rules about business management. Consult with a lawyer to make sure you are not violating these rules and exposing yourself to personal liability.
Pass-through taxation: For taxation purposes, income from your business can be treated as your own personal income, and is therefore not subject to certain federal taxes for which corporations are liable.
Limitless ownership: Some legal structures limit the number of people allowed to file as owners. With an LLC, there is no limit to the number of owners. An LLC can have one member or hundreds of members.
Allocation flexibility: In an LLC, the amount of money that owners invest into the business doesn’t need to equal their percentage of ownership. When an LLC is formed, members create an operating agreement, in which different percentages of company profits and losses can be assigned to owners regardless of the amounts of their initial investments. So you can make a deal with an investor to have them finance half of your business without necessarily owning have of your business.
Freedom in management: Unlike standard corporations, LLCs are not required to have a board of directors, annual meetings, or strict book requirements. This can free up a lot of time and stress to let you run your business on your own terms. As you can imagine, this can be an important advantage of a limited liability company as well.
Disadvantages of a Limited Liability Company
Building capital: Unlike corporations, which can issue stock in order to increase funds for their companies, LLCs have to work a little harder to find investors and sources of capital due to the greater legal obligations and state filings involved to add a new member to an LLC. If you have a fast growth internet company that needs venture capital to scale, this limitation is one of the major disadvantages of a limited liability company.
Higher fees: LLCs must typically pay more fees to file as LLCs compared to some other business entities or sole proprietorships. Additionally, many states require yearly renewal fees. However, these fees are usually less than what a C-corporation has to pay.
Government regulation: Because of the protections afforded to LLCs, some types of businesses are ineligible to file as LLCs. Banks, insurance companies, and medical service companies are examples of businesses that may be barred from filing in your state. These rules can vary from one state to the next, however. So find out from a business formation lawyer whether an LLC is a possibility for your company.
Lack of case law: The LLC business form is a relatively new concept. As a result, not a lot of cases have been decided surrounding LLCs. Case law is important because of predictability. If you know a court has ruled a certain way, you can act accordingly to protect yourself. But if few laws have been established yet, there is a certain level of vulnerability with your operations that could expose you to greater liability.
Taxation: Although LLCs allow owners to avoid federal taxes, your firm may actually end up paying more that it would with a different model, depending upon your state’s personal income tax requirements, and the nature of the business. Working with an accountant and/or tax lawyer is a really good idea when planning your business and forming your LLC.
Confusion across states: The rules regarding LLCs vary from state to state. If you decide to start doing business in multiple states, it may become tricky to understand and abide by all the requirements of each state, and in some cases it may be necessary or preferred to form subsidiary entities to operate in other states.
Next Steps to Forming an LLC
Once you have considered the advantages and disadvantages of a limited liability company, if you think an LLC is the right choice for your business, you should find an attorney to help you form the LLC and draft your operating agreement. A carefully worded operating agreement can save you and your business partners from unseen issues and help resolve disagreements down the road. For example, when one member decides they want to leave the LLC, most states require that the LLC break up, all assets be divided, and a new business entity be formed. In a well drafted operating agreement, you can have a clause about how your LLC will deal with members leaving that can keep the business running and help prevent this kind of headache. Finding a business formation attorney who understands your needs is a critical step in the successful structuring, formation, and planning of any new business.
Learning about how LLCs operate and becoming aware of the key advantages and disadvantages of a limited liability company is an important step in your path to one day establishing a successful business. By properly planning and structuring your company from a legal standpoint early on, you will give yourself a better chance of success and of avoiding lawsuits, disagreements, and other legal issues in the future.