What is a Limited Liability Company (LLC)?
One of the most important decisions you’ll make when starting a new business is choosing a structure, also known as a business entity. Many small business owners opt for an LLC as it’s inexpensive to form and relatively simple to maintain.
But the LLC structure supports you in other ways too:
It gives you the confidence to walk the tightrope of entrepreneurialism and provides a safety net should you fall. An LLC also provides your business with an air of professionalism and can help obtain funding when you need to expand.
Ultimately, the LLC entity exists to promote entrepreneurialism and help business owners like you think big and plan for the future.
Why is an LLC So Important?
An LLC is just one of several business structure choices available when creating a business. But an LLC differs from other entities because you can start small and scale at tremendous speed.
You can run an LLC alone, known as a single-member LLC, or with a team of people, known as a multi-member LLC.
Another reason why an LLC is such a popular choice for small business owners is because of the limited liability protection and the simplified tax structure.
For example, forming an LLC is the easiest way to secure your assets against litigation, as claims are limited to the total value of the business.
And LLCs are pass-through entities, meaning your tax structure is equal to a partnership and sole proprietorship. I’ll explain your tax requirements a little later in the post.
LLC as a Business Structure
Before you start your business, you must first choose your business structure and register with your state.
Factors that can influence your structure choice include whether you’ll have employees, need funding, and aspirations for future growth.
You have several business structures to choose from, including:
3. Limited liability partnership
4. General partnership
5. Sole proprietorship
But it’s the balance of flexibility and protection that makes an LLC the perfect choice.
And there are many other benefits, too. But first, let’s answer the question: When should you consider forming an LLC?
When Should You Consider Forming an LLC?
Anyone starting a new business or already trading without limited liability should consider forming an LLC.
You can use an LLC structure to run almost any type of business. And in some states, specific business models and professionals must form an LLC to trade.
My tip: Only form an LLC when you’ve confirmed your business idea is viable and have written a solid one-page business plan.
Benefits of an LLC
Although the LLC structure has some disadvantages, the benefits often outweigh them.
Choosing an LLC as your business structure can help you in the following ways:
1. It protects your assets against a lawsuit.
2. LLCs are relatively easy to form and maintain.
3. Prevents your company from being subject to double taxation.
4. An LLC offers flexibility, as you can tailor the structure to suit your needs.
5. You’ll get exclusive use of your LLC name in your state.
6. It can help you access a variety of business loans.
7. Increases your business credibility with creditors and customers.
I’ll explain in more detail:
Benefits of an LLC
As an LLC owner, you aren’t personally liable for your business’s financial losses, debts, or in the case of litigation. The only potential loss is the capital (cash, assets) invested in the company.
And as governments classify LLCs as individuals, they can own assets and keep any profits after taxes.
The only time you could be held responsible for losses or litigation is if you’re found guilty of running your business fraudulently or not separating your business transactions from personal ones, known as “piercing the corporate veil.”
Simple to set up
An LLC is easy to set up and maintain because it isn’t required to hold annual meetings, assign formal roles, record company resolutions or minutes of meetings.
You only need to apply the following steps to establish your LLC:
LLCs pay tax as a pass-through entity. Meaning all profits flow through to the owners and investors; members then pay self-employment and income tax on their share of the business’s net income.
Which business types qualify as a pass-through entity?
U.S. businesses taxed as pass-through entities include sole proprietorships, partnerships, limited liability companies, and S-corporations.
Pass-through entities are also called flow-through entities and fiscally transparent entities.
The takeaway: LLC members only pay tax on what they earn and are not subject to corporate income tax or any other entity-level tax.
All businesses are subject to laws they must follow. But LLCs are unique because members can write their operating agreement to change the default laws that govern them.
An operating agreement is a set of rules chosen by its members that outline how an LLC will run. You can divide the management roles equally or select a single member to act as manager.
An LLC also has flexibility with voting rights. You can choose to share managerial decisions based on the percentage of ownership each person has. And tailor the governance structure of your LLC to suit the needs and preferences of its members.
Exclusive use of your LLC name (in your registered state)
When you form an LLC with a state, you must register your trading name to ensure it’s not already in use and prevent another LLC from trading in your state using your name.
However, registering your name in one state doesn’t protect it in the remaining 49. Nor does it prevent a general partnership or sole proprietorship from using your name in your state, but they can’t use it to form an LLC or corporation.
If you want ownership of your business name in all 50 states, you’ll have to trademark it at a national level.
Easier to get loans and credits
While forming an LLC is relatively cheap, many businesses require funding to run and expand into other markets.
Once you form your LLC, you can begin to build a credit history, helping you access business loans and other lines of credit as and when you need them.
Numerous loans are available, but your approval often depends on whether you have collateral, how long your LLC has been trading, its annual revenue, and your business’s credit score.
Your business can have a credit score similar to an individual. Business credit bureaus such as Equifax and Experian hold these scores so creditors, insurance companies, suppliers, and various other organizations can evaluate your financial standing and ability to repay a loan.
Many businesses and consumers often consider non-legal entities, such as a sole proprietorship and general partnership, as “unprofessional.” Of course, it isn’t true, but it’s an unfortunate reality that isn’t good for a new business.
When people see LLC after your name, they know you’re a registered professional entity within your state and are often far quicker to put their confidence in your business.
Disadvantages of an LLC
The LLC structure exists to make life easier for small to medium business owners, so there aren’t too many disadvantages.
But just as in life, it’s never all smooth sailing, so let’s look at what red lights and potential bumps in the road might lie ahead:
Challenging to raise money
While owning an LLC can help you get a business loan, it’s not a guarantee due to being taxed as a pass-through entity.
I’ll explain why: As a pass-through entity, LLC members pay taxes on their share of disbursement. A disbursement is an agreed percentage share of LLCs profits paid to each member. This amount is proportionate to a member’s capital investment and only paid, providing the business first pays its creditors and bills.
However, an LLC is unattractive to investors because members do not own shares, and no bonds or stocks are issued.
If your business should fail, lenders have little to go after, and financial institutions like a safe bet.
Set up cost
LLC setup costs vary depending on which state you’re trading in and your business model. Some states charge an initial formation fee, while others impose other ongoing expenses, including franchise tax and annual report fees.
And there are other costs worth considering before opting to form an LLC. You can find out what yours are by visiting your state’s website.
But here are 5 standard costs:
1. State filing fee
When forming an LLC, your primary setup cost is the fee for filing your LLC’s articles of organization with your Secretary of State. Fees vary depending on your state and range between $40 to $500. Find out more on your Secretary of State’s office website.
2. Registered agent fee
A registered agent is a business or person designated by an LLC to receive legal documents, official government correspondence and accept service of process on the business’s behalf.
You must appoint a registered agent upon filing your articles of organization with the secretary of state.
Most LLC owners opt to appoint a registered agent rather than take this role for themselves for the following reasons:
1. An agent’s address is a matter of public record.
2. Agents must own a registered address within the state of registration.
3. Be open during business hours.
Registered agents charge from $99 to $300 a year, depending on the services you require and the number of states you’re trading in.
3. Business licensing and permit fees
Most businesses require licenses and permits from both state and federal agencies.
And every state has its business license and permits regulatory requirements.
One thing every state has in common is that if you don’t comply, there are costly consequences, such as fines, penalties, late fees, and in the worst-case scenario, the denial to operate.
So, it’s essential that you find what permits and licenses you’ll need before trading. Your requirements and fees vary based on your location, business activities, and government rules.
A business license usually costs a few hundred dollars plus renewal fees but can rise to $500, depending on your state. And for industry-specific licenses, fees can range from $20 to a few thousand dollars.
Filing for a business license varies by license/permit and state. You’ll find the information for obtaining a business license on your county, state, and federal websites.
A word to the wise: It’s highly advisable to seek legal counsel to confirm which licenses and permits apply to your LLC business to avoid unnecessary violations and costs.
4. Operating agreement
An LLC Operating Agreement is a blueprint to the business structure and a record of the following details:
Most states don’t require an LLC to draw up an operating agreement, however, it’s a legal requirement with others. And while not creating one might sound like the easier option, it’s in your best interest to have one.
The best time to make an operating agreement is before you register your business and start trading.
The cost of creating an operating agreement varies depending on its complexity, such as the number of members, their percentage ownership, and designated duties.
Fortunately, an LLC operating agreement doesn’t require notarization (signed by a solicitor); however, you might need a solicitor to advise you on state rules and regulations.
The takeaway is while an operating agreement will take some effort to create, it’s time well spent.
5. State differentiation
You can form an LLC in any state, regardless of where you’re doing business. However, for simplicity’s sake, your home state is often your best option.
The pros of registering in your home state: By forming an LLC in your home state, you have the convenience of familiarity with local state laws and procedures. You’ll probably have contacts there that can advise you. And all necessary government offices are within reach should you need to talk with an official.
The cons of registering in another state and trading in a state where you’re not registered:
1. If you change your state of registration, you’ll have to register as a foreign LLC; costs vary from $50 to $700, depending on the state.
2. If a state finds your business trading while not registered, they could impose penalties and other costs, which won’t be cheap!
3. And you’ll have to designate a registered agent in that state, amounting to additional costs.
Now, this doesn’t mean registering your LLC in another state is out of the question; you have to weigh other factors like convenience to ensure it’s worth your while.
Lower tax is often the primary reason people choose to form an LLC in another state. For example, Wyoming is a business-friendly state, charges zero personal income tax, corporate tax, and a sales tax of only 4.0%.
As you’re self-employed, you must pay self-employment tax, including your Social Security and Medicare taxes, both calculated on a member’s distributed share of the LLC profits. Or where you’re the sole owner, the wage you take from the business.
As an LLC owner, the self-employment tax you’ll pay is 15.3% of your net income before your annual threshold and 2.9% for any payment above.
The downside to tax as an LLC owner is that you’ll pay twice the self-employment tax as an employee because employers match their employees’ tax contributions.
However, as an LLC owner, you can deduct half of your total amount owed from your taxable income, which levels the playing field and saves you some tax dollars.
But there’s an upside of being a non-active LLC owner when it comes to tax! Members of an LLC who don’t contribute to the daily running of the business are considered silent and may be exempt from paying self-employment tax on their percentage share income.
Always check with the IRS website for your annual net income threshold or employ a tax accountant to advise you on your tax requirements.
Member turnover complications:
In many states, if a member of an LLC leaves or dies, you’ll have to dissolve your business and start fresh. It also means the remaining partners will be responsible for all financial and legal obligations of the ex-partner.
It’s unpleasant to think about, but you’ll thank yourself later for having planned.
To Wrap It Up
I hope this post has answered any questions you had and removed any lingering doubts.
But if you’re still unsure, it helps to write a list of the advantages and disadvantages, use ours and include your own.
An LLC structure is meant to make life easier for small to medium business owners. And even though forming an LLC might seem like a huge step right now, it’s a step in the right direction. One that could lead you and your business to a very bright future.
This portion of our website is for informational purposes only. The content is not legal advice. All statements, opinions, recommendations, and conclusions are solely the expression of the author and provided on an as-is basis. Accordingly, Tailor Brands is not responsible for the information as well as has not been evaluated the accuracy and/or completeness of the information.