Over this past year, we have discussed the different types of entities that are available to individuals that are looking to start a business. Thus far, we have specifically addressed some of the benefits and drawbacks associated with c-corporations and s-corporations. This week, we are going to discuss limited liability companies or LLCs and address the situations in which an LLC may be the right entity for your business.
Introduction to LLCs
In the late 1970s, Wyoming became the first state to recognize LLCs, and this entity form has since been codified in every state in the United States. From a legal standpoint, an LLC is very similar to a corporation in that both entity forms offer owners (i.e. shareholders in corporations and members in LLCs) limited liability. This means an owner’s liability is limited to the capital invested in the entity (at least theoretically).
Benefits of LLCs
When compared to corporations, LLCs have several advantages. First, LLCs are generally easier to form than corporations. LLCs do not need to name directors as is necessary with corporations, and the organizers of LLCs do not need to make any determinations in regards to the number or types of shares that will be issued or the par value on the issued shares. Second, LLCs generally have less statutory formalities when compared to corporations. LLCs do not need to have annual meetings and there is no need for LLC members to elect directors or officers. Finally, from a tax standpoint, LLCs have a lot of flexibility. Corporations have limited taxation options; however, LLCs can be taxed as disregarded entities, partnerships, or even as s-corporations. It is completely up to the members of the LLC to determine how the entity will be taxed.
Drawbacks of LLCs
Due to the flexibility that LLCs have when compared to corporations, there are not many drawbacks associated with this entity form. However, if the owners of an entity anticipate bringing on a large number of additional investors, financing through other private equity sources, or eventually taking the company public in an IPO, then an LLC is likely not the right entity form. Corporations are generally bettered vehicles for larger companies or entities backed by private equity firms.
When Should I Form an LLC?
There are a number of different situations in which an LLC would be a great entity for your business. First, you should consider an LLC if you are a sole proprietor looking for protection for your personal assets and do not want the hassle of keeping track of stock certificates or holding annual meetings. For example, a photographer might consider forming an LLC for his or her business. In forming an LLC, the photographer would get the benefit of limited liability without having to deal with the cumbersome formalities that are required in the corporation context.
LLCs are also great options for most small or family-owned businesses that have a limited number of members. For example, an LLC would be a great entity option for a group of individuals starting a coffee shop or a small manufacturing business. An LLC provides these individuals with limited liability, while at the same time giving them the option to choose from various tax treatment options and avoiding the cumbersome formalities of corporations.
Additionally, LLCs are great tools for holding and protecting valuable assets. For example, if you own rental properties you should consider holding each rental property in a separate LLC. Because an LLC can be a disregarded entity, a tax return does not need to be filed for each LLC that owns property. Instead, the income passes through to your individual tax return all the while providing you with the benefit of limited liability.
LLCs are very flexible entity forms and are great options for most individuals looking to start a business. Although there are situations in which an LLC may not be the right option, for the vast majority of startups, small businesses, and entrepreneurs, an LLC is a great tool that should be considered. If you need assistance forming an LLC or a corporation or you have questions about which entity form you should choose, be sure to give Smith Haughey Rice & Roegge a call. We’ll guide you through the formation process quickly and efficiently so you can focus on what really matters: making your first sale!