The ABC’s of starting an LLC

The guide to forming an LLC.

Starting a business comes with some big decisions. One of those decisions is what type of business structure you want. You’ve likely heard of a sole proprietorship, a partnership, or a corporation. But have you considered an LLC? If not, read on for more information that can help you to decide if this type of business structure is right for your company.

Advantages (And Disadvantages) of LLCs

The Advantages of LLCs

  • Businesses that are likely to acquire debt or have the potential of lawsuits — The business doesn’t have to be engaged in dangerous activities to face debt or lawsuit potential. Simply having a shop where you allow the public to enter and purchase items leaves you open to the possibility of claims if someone were to slip and fall. Unlike a sole proprietorship or a partnership, an LLC limits the personal assets of the business owner from becoming a chess piece in settling claims or collecting assets to satisfy a debt.
  • Those who want flexibility. You can have as few or as many owners — referred to as members — as you’d like. The members aren’t required to be citizens of the U.S. or even permanent residents. In fact, they can be individuals, corporations, foreign individuals or corporations, or even other LLCs. The LLC can also just be you. It’s your choice to make.
  • Those who want a simple structure. The process of becoming an LLC is quite simple. Many states allow you to simply file your Articles of Organization with the Secretary of State’s office and pay a filing fee.
  • Those who want the tax benefits of a corporation without the hassle. Unlike a corporation, you’re not required to fill out corporate income tax returns with an LLC. You simply list your profits and losses on your personal return and get the pass-through tax benefits that a corporation provides.
  • Those who want the heightened credibility that comes from having a business that is not a sole proprietorship or a partnership. Often sole proprietors and partners are referred to as “mom and pop” businesses. While there’s nothing wrong with that, the LLC can appear and sound a bit more official to partners and lenders.
  • Those who don’t want to be bogged down with compliance issues. All other business structures are heavier on the formalities.

The Disadvantages of LLCs

  • Eligibility issues. Not all types of businesses are eligible. For example, banks and insurance companies are prohibited from being LLCs. In some states, other professions are also banned from creating LLCs, including architects, accountants, doctors, and healthcare workers.
  • Limited growth potential. LLCs cannot issue stocks to investors.
  • Potential liability. If you fail to meet the state’s regulations for starting and maintaining your LLC, or the IRS or state believes you have used the business to commit fraud, you could lose your liability protection.
  • Lack of uniformity. The laws and requirements surrounding LLCs may be vastly different from state to state. Additionally, this business structure is only recognized in the U.S., meaning you are unable to go to a foreign country and start an LLC there.
  • The potential of increased taxes. Some LLC members face taxes such as the self-employment tax or appreciation of assets.
  • Start-up expenses. The filing fee for forming an LLC is often more expensive than forming a sole proprietorship or a partnership. States may also charge ongoing fees to maintain the LLC.
  • Risk of dissolution. Depending on state laws, an LLC may be dissolved if one partner dies or files bankruptcy.

Business Structure Comparison

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So how does an LLC stack up against other structures? Let’s take a look.

LLC vs. Sole Proprietorship

LLC vs. Partnership

A partnership, on the other hand, is a business that operates under the names of its owners. When a partnership owes money or faces legal liability, so do its partners. Partnerships are disregarded as business entities, and business income is taxed as personal income in proportion to each partner’s ownership of the business.

Each of these structures provides flexible management that is largely up to the owners/ members to decide. LLCs may have an operating agreement that is similar to the partnership agreement in the delegation of ownership and responsibilities.

LLC vs. S-Corp

LLCs can actually choose to pay taxes as an S-Corp and may save money by doing so. Not all businesses are eligible for S-Corp status, however, including LLCs that are owned by foreign entities or have an owner who is a foreign citizen, as well as those that have a single owner and are structured where the owner is a partnership or a corporation.

LLC vs. Corporation

Corporations are heavily regulated, requiring a number of business formalities, including an annual shareholder meeting that must be reported to the state. Corporations may increase their profits and grow through the sale of stocks. An LLC cannot issue stocks to investors. LLCs may add owners regardless of the financial contribution that anyone pays as part of that ownership. The liability protections afforded to a corporation have been around much longer than those pertaining to an LLC and therefore tend to be uniform from state to state.

Creating an LLC

Choosing a State

Choosing a Name

Also, make sure it’s legal. Many states have required words and restricted words when it comes to business names. You will want to include the words “Limited Liability Company” or “LLC” in your name. Obviously, profanity is not a good idea when it comes to choosing a name. States also prevent LLCs from using the words “Bank” or “Insurance” in their names, as well as other words. If you aren’t sure if the words included in your desired business name are legal, check with your Secretary of State’s office to see if they can provide you with a list of restricted words.

Do You Need a Registered Agent?

The Operating Agreement

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While these documents are required in every state, some states only require you to have an oral agreement. However, developing a written operating agreement is strongly recommended, as it signifies that the LLC is an official business if a question of debt or legal liability of the members ever arises. Some of the issues that an operating agreement may address include:

  • The authority designated to each of its members
  • When a vote is needed to approve transactions
  • Transferring interests to new members or adding new members
  • How profits and losses should be split among members

An operating agreement allows the members of an LLC to decide their own destiny. In the absence of a written operating agreement, if there is a discrepancy among members, the state’s default rules will apply.

Filing Your Articles of Organization

Additional Provisions

You may also need to open a business bank account. While you’re not legally required to do so, it is generally good business practice to keep your company’s banking business separate from your personal banking. This also further reinforces the limited liability aspect of your business structure.

And if you plan on doing business in other states, you will need to register your business in those states in accordance with each state’s laws.

Converting to an LLC

It’s an Important Decision

Ultimately, it’s your decision and you should take into consideration the type of business and your business needs.

Originally published at on January 16, 2020.

Written by

Australian lawyer. Living in Asia. Writing about Law, Finance, Wall Street & Startups.

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