A Limited Liability Company is a great business structure to consider, no matter what type of business you plan to run. The many benefits of an LLC allow business owners to build the company they desire while minimizing hardships along the way. This article explains the LLC advantages and disadvantages you’ll want to know about before starting a business of your own.
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Pros and Cons of an LLC – Overview
- Personal Liability Protection
- Various Tax Options
- Management Flexibility
- Profit Distribution Flexibility
- Builds Business Credibility
- Minimal Paperwork
- Easy to Form
- Good for Individuals
- Consequences of Member Turnover
- Self-Employment Taxes
- Role Confusion
- Can Be Challenging to Raise Capital
- Can Be Expensive to Set Up
What are the Benefits of Starting an LLC?
There are several benefits of having an LLC as your business structure, no matter the size of your company. Here are some of the top benefits of an LLC to consider when deciding how to create your startup.
Personal Liability Protection
Perhaps the most standout benefit of starting an LLC is the personal liability protection they offer. As the owner of an LLC, your home, car, savings, and the like are secure even when your business can’t cover a debt, fee, or payment on a loan. This protection holds true for each member you have, whether one or several.
Sole proprietorships and partnerships offer no such protection, making your personal finances fair game in the event of a lawsuit or money issue. If there’s any level of risk with your business, an LLC can keep you safe.
If you ever find yourself signing a personal guarantee for a business debt, your personal assets may come into play if your business can’t handle the expense. Other situations where personal liability protection won’t help are combining personal and business funds, committing fraud, breaching your duties as owner of an LLC, or causing harm due to negligence.
As an LLC, you and your other members have a few options to choose from when setting up a tax structure. The business structure does not have its own tax classification and can choose the preferred tax status of another business entity. The four options available to LLCs are:
- Sole proprietorship: For single owners only, sole proprietorships don’t pay taxes at the corporate level and instead pass all profits through to the owner. The owner then pays income taxes on this entire amount. Known as pass-through taxation, it allows sole proprietorships to avoid double taxes. The government still considers members self-employed and is subject to self-employment taxes as well.
- Partnership: Partnerships always consist of multiple members, but business profits still pass down to each owner without paying taxes at the corporate level. Each owner then pays income taxes on their portion of the profits. In most cases, members have to pay self-employment taxes on income as well.
- S Corporation: S corporations similarly have pass-through tax structures to dodge double taxation. Owners can choose to receive a salary from profits and pay payroll taxes on that amount. All other profits pass through the corporate tax level to members, who must pay income tax on their portion of the amount.
- C Corporation: A C corporation is the one business model to pay taxes at the corporate level. Any profits taken by members are taxed a second time as income.
Each of these tax options can be favorable to LLCs at various stages of operation. It’s possible to change tax status as an LLC, but the Internal Revenue Service (IRS) typically only allows such a move once every 60 months.
Unless you decide otherwise, your LLC defaults to the pass-through taxation guidelines of a sole proprietorship or partnership, depending on whether you have one or more members. Being able to avoid paying taxes at the corporate level can be a massive boon for LLCs just starting out.
When creating an LLC, members can decide to run the show themselves or hire a manager to oversee day-to-day operations.
Individuals with or without other employees have the freedom to create a business the way they see fit and run it how they choose. LLCs with multiple owners having an understanding of a company’s inner workings can run different departments to ensure the business functions as intended.
Those without expertise in running an organization can hire or appoint a manager to control the workings of the business. Members may choose a more passive role or remain involved in some way.
Read more about member-managed vs manager-managed LLCs.
It’s up to you as a business owner to decide how the leadership structure of your LLC operates. There are no limits regarding how many members an LLC can have, nor is there a requirement to maintain a rigid board of directors that corporations must maintain.
LLCs don’t have a fixed management structure, which is quite different from other business structures. With partnerships, owners must split profits evenly between themselves. Corporations have shareholders who receive profits based on how many shares each one has.
Members of an LLC get to choose how to distribute profits, however, this must be planned out in your LLC operating agreement. If a particular owner invests more time or capital, that person can bring in a greater share of earnings than others do. It’s up to the current ownership to decide how distributions of income work at the time of startup, but even this can change as a company grows.
You may need to provide reasoning behind the disbursement of profits to the IRS when filing taxes. It must be clear that distributions reflect leadership structure and aren’t an attempt for one or more members to avoid falling into a higher tax bracket.
Partnerships and sole proprietorships are legitimate business models, but they don’t always appear very credible on paper. Businesses and customers you deal with typically see LLCs as more credible, professional, and trustworthy.
Your business must include some form of the “LLC” or “limited liability company” in your name, further cementing your status as a company worth doing business with.
With few exceptions, forming an LLC in your state gives you unique access to the name you choose for your business. Other companies can’t come along and create a name identical or similar to yours, offering you a niche to work out of.
Businesses in other states can still use the same name as you unless you register an LLC there as well. If you’re thinking of expanding to a nearby state, it may be prudent to do so. Some states will allow you to reserve a name for a set number of months while you get your affairs in order.
Another huge perk of forming an LLC is the minimal amount of paperwork needed to get your business off the ground.
Unlike corporations, LLCs don’t have to hold meetings or record meeting minutes. There’s no need for a board of directors or officers and the paperwork required to maintain those positions. Less record-keeping allows members to focus on other matters instead.
At formation, LLCs should establish an Operating Agreement containing all the rules those in your business need to follow. Without this document, your LLC must adhere to the state’s regulations, whether they make sense for your company or not.
Many states do require annual reports summarizing changes made during the last year to keep government records current. Requirements for each state vary considerably, but the paperwork is usually still minimal.
Easy to Form
When the time is right to create your LLC, the process is quite simple. There may be subtle differences depending on the state you form in, but it is something you can do without the help of an attorney.
Below are the steps any business owner needs to follow when setting up an LLC. You can also hire one of the best LLC formation services to create and enjoy the benefits of your LLC at an affordable price.
Step 1: Choose your state
Most business owners prefer to start out in the state they live in, considering they already have knowledge of how the state runs. Delaware and Wyoming can be great options for registering a business, thanks to business-friendly processes and tax perks.
Step 2: Name your business
As mentioned earlier, you’ll have to come up with a name someone’s not already using in your state. Be sure to follow any state guidelines for naming and avoid anything that may mislead customers.
Step 3: Hire a Registered Agent
A registered agent handles legal and state matters that come your business’s way. You can choose to be your own registered agent, but most LLCs look to knowledgeable registered agent services to handle this role.
Step 4: File Articles of Organization
Articles of organization is the sole document you need to file with the state. It provides the government with the into it needs to approve formation.
Step 5: Write an Operating Agreement
This agreement stays within your LLC and should provide a financial, operational, and legal footprint for members and employees to follow. Not creating an operating agreement puts your business into the hands of state government guidelines when disagreements occur.
Step 6: Get an Employee Identification Number (EIN)
An EIN (Employer Identification Number) is effectively a tax code for your business. LLCs with more than one member require an employee identification number, but you can pick one up for free from the IRS.
Good for Individuals
LLCs work well for large businesses, but the business structure serves just as well for individuals building a small venture from scratch. A single business owner without employees still receives the limited liability protection and tax flexibility a larger LLC does. As your business grows, you can modify facets of your LLC to accommodate more staff or additional owners.
Disadvantages of an LLC
Unfortunately, not everything having to do with an LLC is an upside. Here are a few disadvantages to keep in mind when choosing an LLC as your business structure.
Consequences of Member Turnover
Members are the backbone of an LLC and can cause havoc if one or more choose to leave. Owners need to carefully redistribute profits, and states may have specific roles regarding the matter. In some instances, the state may require the dissolution of an LLC after just one member departs.
This sticky situation doesn’t occur in corporations that constantly see shareholders coming and going as shares trade from one person to the next. With an LLC, it is possible to curb some of the chaos through careful documentation in an Operating Agreement.
Unless you’ve chosen to follow a corporate tax structure, the IRS records LLCs as partnerships or sole proprietorships, depending on the number of owners. In these instances, owners are still considered to be self-employed.
Self-employed members must pay Social Security and Medicare taxes in an amount relative to what the business earns. This self-employment tax is in addition to income taxes on profits.
Corporations offer clear roles between owners, directors, and employees with rigid rules about how each one functions. LLCs, on the other hand, do not have such requirements. Without guidelines in place, it can be very confusing to know who can perform certain functions and where divisions of responsibilities lie among higher-ups.
LLCs can create clear-cut lines with the help of an Operating Agreement so long as members take the time to properly flesh the document out.
Can Be Challenging to Raise Capital
Most LLCs will need money at some point, but the business structure doesn’t provide clear opportunities for investors to get involved. Because of the way LLCs do ownership, it’s not nearly as simple to add members as it is with a corporation.
Many investors are similarly deterred by an LLC’s tax-exempt status, as investments can create unrelated taxable income.
A limited liability company is more expensive to form than your average sole proprietorship or partnership, which can be a deterrent to someone just starting out. State fees can be well into the hundreds per year, a difficult challenge to surmount with little to no income flowing in.
In many states, there’s no cost for starting up a sole proprietorship. Those wishing to use a DBA still pay far less in fees.
Benefits of an LLC – Frequently Asked Questions (FAQs)
The benefits of an LLC play a major part in determining which business structure to use for your business, but they don’t offer the complete picture. This FAQ serves to answer additional questions you may have about limited liability companies.
Bottom Line on the Benefits of an LLC
The benefits of an LLC far outweigh the negatives, providing an opportunity for those starting a business to protect personal finances while offering pass-through taxation. As LLCs grow, their flexible nature allows for changes while keeping paperwork to a minimum. Easy formation is the cherry on top that should have all new businesses considering LLCs at startup.
To make the process even easier, those wishing to start an LLC can turn to ZenBusiness for all their setup needs. The LLC service has the knowledge to create a business in any state for as low as $49 before state fees.
Sign up for ZenBusiness today to ensure your LLC kicks off without a hitch.