If you are about to start up your own business, then you will be aware that there are several business models from which to choose. The particular business structure you opt for when forming your company can be dependent on several factors but will ultimately come down to what you feel suits you and the business you intend to operate best. Limited liability companies are one of the most rapidly growing business structures around. Here, we’ll explain just what an LLC is to help you decide whether or not is the business structure for you.
Types of Business Entity
In essence, a business entity is any group that has been put together with the intention of trading goods or providing a service. How your business will be organized from a managerial perspective and how it will be taxed will be dependent on the structure you opt for. Here are four of the most popular types of business structure.
- Sole proprietorship;
- Limited Liability Company;
Deciding upon the type of business entity you wish to run is a decision that needs to be made early on. Your choice, whichever it is, will have financial implications – as well as legal ones: the rules and regulations vary from state to state, and some stipulations are mandatory and configured per particular business entity type. So careful consideration is needed before settling on the structure that you want for your company. If you are uncertain as to the differences between the four most popular models, here’s a quick breakdown.
A sole proprietorship is just as it sounds: it’s a business that is owned and run by one sole individual. Sole proprietorships avoid double taxation and – importantly – will not protect the owner from any personal liabilities. The owner’s personal financial assets, property, and vehicle/s are in the firing line in the event of debt collection and other legal woes relating to the recovery of debts. Sole proprietorships are ‘pass-through’ entities in the eyes of the IRS – meaning that the taxes for the business trickle down to members’ own personal tax returns. Both are taxed as one: business merges into the personal – they are not kept separate.
Partnerships share some key components with sole proprietorships. The main difference is that the enterprise is owned by more than one person. Just as profit will (usually) be distributed equally or in ratio with the percentage of stake in the business, should the business run into trouble with debt collection and other financial grief, all parties will be liable. A key factor in businesses being formed as partnerships is risk reduction. Having more than one person onboard lessens the damage if the business doesn’t work out. With a sole proprietorship going wrong, the lone owner takes the full brunt of the hit, should the enterprise not go as hoped.
Corporations differ from other business entities in that the owners are shareholders of the company. There are two types of corporations: S Corps and C Corps. C Corporations are popular for larger-sized companies and for those that have shares that are traded publicly. S Corps are similar – and still have the liability protection of S Corps – but are considered pass-through entities by the IRS, just as sole proprietorships are. C Corps, on the other hand, are double-taxed: the company will pay corporate tax, and the shareholders must pay taxes on their personal returns.
What is a Limited Liability Company?
So that’s a quick summation of some key differences between a sole proprietorship, partnerships, and corporations – what is a limited liability company? An LLC is a business entity, which is essentially a hybrid of the aforementioned business structures, taking elements from each and making it one of the most versatile business models available. This mash-up of elements and its versatility is what has made LLCs so relentlessly popular and the preferred structure for most first-time entrepreneurs entering the world of small business.
LLCs, though requiring a lot of paperwork to be filed with the state, are one of the easiest business entities to form. They have the management informality of a partnership while simultaneously having the formalities of offices and an appointed manager. LLCs can be run with the simplicity of a sole proprietorship while having the protections of corporations. They also count as pass-through entities with the IRS. The profits will go directly to the owner (or owners) meaning they are taxed with personal returns, not separately. The chief pro of an LLC is the limited liability of its title. With an LLC, in the event of bankruptcy or other legal action against it, only the assets of the business will be in the firing line. The personal assets – property, bank accounts, vehicles – of the owner/s are protected by the LLC barrier keeping the personal and the business separate.
Types of LLCs
There are several types of limited liability companies:
- Single-member: A single-member LLC is just that. It’s owned and registered to just one individual who oversees the business in its entirety;
- Multi-member: These LLCs are made up of two or more owners, all of whom have a financial stake in the company. It could be equal, or as in the case of three members, have one member with a 50% investment and two members with a 25% stakehold. Any profits are then distributed accordingly to the percentage of each member’s ownership;
- Member-managed: This is a common management structure for multi-member LLCs. This means that all owners play a role in overseeing the day-to-day operational activities of the business;
- Manager-managed: Some multi-member LLCs don’t want the responsibility of the actual management of the company and will hire a third party to put on the payroll as a manager. Alternatively, a member can become the manager of the business’s activities after a vote by company members if all are in agreement with such a thing;
- Domestic: A domestic business entity is simply one that operates its business practices within the state in which it was originally registered and formed;
- Foreign: This term is applicable when an LLC was created in one state but is now conducting its business in another. If an LLC was formed and first established in Wyoming, this ‘HQ’ would be considered domestic to Wyoming. If this business were to then open a branch in Montana, the Montana operation would be deemed ‘foreign’ by the state.
Pros and Cons of LLCs
As with anything else, there are distinct advantages and disadvantages of opting for the limited liability business structure.
For a first-time entrepreneur, one immediate key advantage is the simplicity of limited liability companies. They are relatively simple to understand from the legal side of things, and they come with considerably fewer formalities and less red tape than corporations.
Come tax time, the IRS will give you the option to file as a corporation if you wish to, and then, of course, there is the foundation of the whole LLC principal – the limited liability of its owner/s. This liability protection places a barrier between the business and the personal. Therefore, in a worst-case scenario event such as legal action by debt collectors or bankruptcy, only business assets are accessible in lieu of money owed. The personal assets of an LLC’s members, things such as non-business bank accounts, home, car, etc., are all protected and kept safe from any action enforced by the courts.
An LLC is also considered a pass-through entity by the IRS, so the business itself will not have its income taxed. Any profit generated by the company will be handed directly – passed through – to its owner/s, meaning that the business revenue is instead included with personal income tax returns.
Another plus in regards to the flexibility of an LLC is that once established, it can be used as an umbrella organization. With an LLC up and running, it’s possible to then create and form other businesses from under the same roof.
Though much easier to form and get up and running than some other business structures, for all the positives and flexibility, LLCs don’t come without their drawbacks. Despite the simplicity, they can be expensive to set up – certainly when compared to sole proprietorships and partnerships. They also have limits. Without the ability to share and sell stock (as with a corporation), it may not be as easy to generate money, especially if you are having trouble finding other investors should you need to raise some more financial input.
Another financial factor to keep in mind is the risk of termination. It’s crucial for LLC owners to keep their personal monetary dealings and those of the business separate. If the lines begin to blur, or worse, cross over entirely, with no clear distinction between the two, the entire structure of the business is set up for catastrophic consequences.
How to Create an LLC
So, when you have decided that an LLC is the business structure you want for your enterprise, how do you go about setting it up? The specific rules and regs do vary slightly between states, however, there is an approximate template when it comes to creating an LLC:
- Do a business name search to ensure the name you wish to use for your company is available;
- Once you know your name is there for the taking, you will need to file Articles of Organization and an Operating Agreement, usually with the Secretary of State. These documents outline the specifics of your intended operation: the name of the business, its location and mailing address, who its members are, the intended purpose of the business and its activities, how the business will be managed, and so forth.
Each state will have a list of compliances that need to be met in order for the business to be given legal authority to operate. It sounds like a lot – and it is – which is why there is an abundance of LLC Business Formation providers on the market to help you.
These companies are in the business of helping others establish their own businesses, shouldering the responsibility of filing the correct paperwork at the right time with the state. The services offered by these companies usually come in tiered packages, with various options available depending on the requirement. They cost money but most are reasonable and offer peace of mind with regard to the handling of the necessary legalities involved with formation.