Since its inception in the late 70s, a limited liability company (LLC) has been one of U.S. entrepreneurs’ most popular business entities.
While the cost to create an LLC varies widely from state to state, company owners often feel it’s worth the expense to have their business and personal assets kept legally separately. This feature affords them a significant level of asset protection from damage claims and other perils that could jeopardize the success of their ventures.
But, like other entity options, LLC business structures have their advantages and disadvantages. This article will briefly examine the primary issues and benefits you can expect if you form a limited liability company.
Advantages of Forming an LLC
Simple to Form and Maintain
Unlike its corporation and partnership counterparts, an LLC is fairly straightforward and requires minimal upfront costs. Most states have uncomplicated registration packets that you can download for free, fill out, and then send back with the filing costs. Or, you can opt to go through an online service that handles all the paperwork for you by having you answer a quick questionnaire about your business.
However, currently, every state requires an Articles of Organization to be submitted, but again, this is a fairly standard document you can download and fill in your specific company details. Likewise, operating agreements aren’t necessarily required but check with your Secretary of State first to be sure.
Other than business licensing for your industry and minor annual reporting requirements by the state your operations are based, LLCs are a breeze to manage.
Personal Liability
LLCs are unique because they provide business owners personal liability protection for their private assets. You shouldn’t have to worry about a creditor you owe a business debt to coming after your family home.
However, this doesn’t mean your personal assets are completely safe. For example, if you’re unable to pay a judgment against your company and its resources, you may need to dip into your own pocket to cover the rest. Or, have a comprehensive business owner’s policy (BOP) in place for these incidents and protect both your company and your personal assets from judgments.
Pass-Through Taxation
Another key advantage of forming an LLC is the tax benefit. The IRS lets your profits “pass through” to your individual return with this business structure. This allows you to choose how you want to be taxed, and most business owners use their personal tax rate. What’s more, you can find out the best states to form an LLC based on their taxation policies and enjoy additional tax benefits too.”
Your LLC won’t have to worry about federal corporate taxation either. The IRS won’t be able to double tax your earnings like it can on revenue distributions to corporate shareholders.
Business Credibility
One of the most challenging aspects of obtaining funding for any company is establishing its credibility with creditors. An LLC legitimatizes businesses because of the registration with the state and IRS. This helps lenders get a clearer snapshot of your venture and build the confidence you can repay your commercial debts.
Management Options
When forming your LLC, you have two options to choose from in how it will be managed:
- Member-Managed – all members of your LLC handle company operations
- Manager-Managed – the members choose a manager to handle company operations
It’s common for LLCs to use a manager-managed approach so that owners can focus on other investment opportunities. A board of directors isn’t necessary to create an LLC, unlike corporations that have to hold regular meetings, record minutes, etc.
Flexible Profit Distribution
While most LLCs will distribute profits according to an owning member’s stake percentage, it’s completely up to you how to do it. Make sure that any distribution scale you choose and payment method are outlined clearly in your operating agreement.
Lien Protection
One of the risks you’ll face having an LLC is personal debt and the creditors seeking that money. It’s possible to lose your ownership stake if a court rules against them in a creditor lawsuit.
Fortunately, charging orders exist to allow a lien to only be placed against the owing member’s earnings, thus protecting the other owners’ interests. This ensures that an outside party, such as creditors, won’t have any authority to run your company through the indebted member’s stake.
LLC Disadvantages
Startup Costs
LLCs indeed are one of the least expensive businesses to form and maintain, but registration filings depend on where you’re registering. Some states charge as much as $500 plus additional fees throughout the year. You might be able to budget ahead if these annual reporting and processing expenses are flat rates, but some states charge according to revenue. So, be sure to do your research!
You will also need to comply with any regulatory requirements for your industry. This means obtaining special licensing for the type of business activities you’ll be engaging in. For example, if you plan to own a bar and grill restaurant, you’ll need liquor licensing, health inspections, food establishment licenses, and more.
Minimal Liability Protection
As mentioned earlier, LLCs have built-in liability protection that legally separates your business and personal assets. This means you won’t have personal liability when things go wrong. However, that is as far as this feature goes because it’s not insurance.
If a customer gets hurt on your premises, they can sue you if they can prove it’s your fault through negligence or other reason the court believes. If you purchase a general liability business policy, these situations won’t dent your wallet or your reputation because the insurer shoulders the burden for you.
Some states require businesses to carry this coverage and a workers’ compensation policy. However, other situations not covered by general liability cause third-party damages, including scenarios like a hairdresser burning a client’s scalp. This is a professional mistake and requires a higher level of insurance to cover because general policies do not.
To determine what policies would best protect your business, you can get quotes and buy LLC insurance online. There’s no excuse for not adequately protecting the best interests of your customers, employees, and business.
Transferring Ownership
LLCs aren’t publicly traded companies with stock to trade as a corporation can. Because of this reality, transferring all or part of your ownership stake to another party can be challenging. If you have multiple members, they all must agree on the proposed ownership change.
However, you may be able to create a definitive process in your operating agreement that outlines mediation options and other solutions when members can’t agree.
