Although there are many ways of organizing your small business, one of the best options is to create an LLC. That’s because LLCs offer a number of potential advantages over other business structures like sole proprietorships and corporations.
In this article, we cover the different ways you can structure your small business and all the advantages and disadvantages of an LLC so that you can make an informed decision for your business.
Different Options for Structuring a Company
When beginning a business, you must decide what form of business entity to establish. Most importantly, your form of business determines which income tax return form you have to file. The most common forms of business include:
Sole Proprietorship - This is where a single person is the owner of the business. The owner does not have any protection from personal liability for business debts.
General Partnership -This is the simplest arrangement where two or more people own a business. The partners do not have any protection from personal liability for business debts, or for actions of the other partners taken within the scope of the business.
Limited Partnership - A limited partnership has two types of owners: general partners (who operate the business, make the decisions, and have personal liability), and limited partners (who are basically investors who do not have the right to operate the business or make business decisions, and do not have personal liability for business debts).
Commonly favored by small businesses, an LLC is a legal entity that combines the limited liability protection of a corporation with the tax benefits of a partnership.
Corporation - In many ways similar to an LLC, a corporation is owned by the investors (called shareholders or stockholders), who provide the funds, assets, or services used to operate the business. The shareholders elect a board of directors, who are primarily responsible for major business decisions. The board of directors also selects officers, who are responsible for the day-to-day operation of the business. In a small corporation, the shareholders may also be the directors and officers.
What is an LLC?
A Limited Liability Company is a type of business organization allowed by state law in the United States. Its structure combines the simplicity, flexibility, and tax advantages of a partnership with the personal liability protection of a corporation.
Owners of an LLC are called “members.” Members of an LLC can be individuals or other businesses, and there is no limit to how many members an LLC can have.
Benefits of an LLC?
The benefits of creating an LLC over a sole proprietorship or general partnership usually outweigh any perceived disadvantages. Here a some of the best reasons to create an LLC for your small business.
Easy to Setup
You can easily set up your LLC on your own without the guidance of a lawyer or accountant. The initial paperwork and fees for an LLC are barebones, depending on the state in which you file.
There is also much less annual paperwork and reports to file. Corporations must hold annual meetings and are required to keep extensive records. LLCs on the other hand are not required to maintain the same level of bookkeeping in many states.
Members of an LLC will not be held personally liable for the actions of the company. This means that members’ personal assets are protected from creditors seeking to collect from the business. This is one of the main reasons why small businesses choose to create an LLC.
An LLC uses something called pass-through federal taxation on profits. This means that the business’ profits go directly to its members without being taxed by the government on the company level. Members instead pay taxes on the profits on their personal federal tax income returns. Pass-through taxation is a system of taxation that most often applies to sole proprietorships, partnerships, LLCs, and S corps.
Members can manage an LLC. LLCs can choose between member-managed or manager-managed. Member-managed means that the members are actively involved in the business's day-to-day operations. A manager-managed LLC has its members delegate the responsibility of managing the company to a manager that may or may not be a member of the LLC. LLCs are not required to have a board of directors, which allows management to be more independent.
Having an LLC increases the credibility of your business by adding another layer of professionalism. Customers and other businesses will find an LLC more credible, and forming an LLC can show people that you are taking your business seriously.
Disadvantages of an LLC
While forming an LLC is a great option for some businesses, there are some potential disadvantages of LLCs that might not make it a great fit for everyone.
An LLC usually costs more to form and maintain than a sole proprietorship or general partnership. The main cost of forming an LLC is the state filing fee, which ranges between $40 and $500, depending on your state. Many states also impose ongoing fees, such as annual report and/or franchise tax fees.
Ownership in an LLC is often harder to transfer than with a corporation. With corporations, shares of stock can be sold by the corporation to increase ownership and, unless there is a shareholder agreement to the contrary, the shareholders can sell their shares to someone else. Typically, with LLCs, unless the members agree otherwise, all members must approve adding new members or altering the ownership percentages of existing members.
Big investors typically prefer to invest in corporations over LLCs. So, if you think your business is going to need a large private equity investment in the future, a corporation might be a better option.
Is an LLC right for your small business?
In summary, creating an LLC for your business is an inexpensive and easy way to boost credibility, gain personal liability protection, and take advantage of any state and federal tax benefits. If you are looking to take the next step with your small business, creating an LLC is one of the best options.