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Limited Liability Company

When you are looking at starting your own business, the Limited Liability Company (LLC) is an attractive option in many circumstances. The LLC business structure combines the benefits of a corporation and a partnership, while eliminating some of the drawbacks of each of those business structures.

In this course, we will review the different components and issues related to an LLC to help you determine if it is the best business structure for you.

LLC History

The LLC first came into being in 1977. The State of Wyoming passed a law that year creating a new business structure, combining the liability protection of a corporation with the pass through taxation of a partnership. In 1996, Hawaii, Massachusetts and Vermont became the last States to pass statutes authorizing LLC creation. Although each State and the District of Columbia allow the formation of the LLC, the laws are not all exactly the same. Requirements for creation, rights of an LLC, and restrictions on an LLC may vary from State to State; therefore, it is important for you to understand the laws of your State when considering an LLC as your business structure. 

LLC Defined

The LLC is a hybrid business structure which combines aspects of a corporation and a partnership. An LLC is like a corporation in that it is a separate entity from its owner(s) and, therefore, protects them from personal liability for the debts and obligations of the business. An LLC is like a partnership in that it is not taxed as a separate entity; instead, the LLC income passes directly through to the owner(s) of the LLC.

LLC ownership is denoted by membership, and can be in a single person, or a group of people. In a single member LLC business, control and income are typically limited to that single member. In multiple member LLCs, the distribution of control and income are typically outlined in an operating agreement or similar document.

Is an LLC Right for You?

There are four primary ways to determine whether the LLC business structure is appropriate for your business:

  • Potential risks or liabilities of your business type

  • Costs and details in starting and operating LLC

  • Taxation questions

  • Financing

Each of these four areas is important when determining whether the LLC is appropriate for your new business. Let’s take a look at each with a little more detail.

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#1: Potential Business Risks and Liabilities

Anytime you enter into a new endeavor there will be risks. Assessing these risks appropriately will go a long way in determining whether you will need the protection an LLC can provide. An LLC, like a corporation, is a separate entity from the individual(s) who own it. The fact that it is a separate entity will act as a shield for you personally, which will protect you from being personally responsible for the debts and obligations of the business in the event it is unable to satisfy those debts or obligations.

Risk Assessment

As you assess the potential risks of your new business, consider the following:

  • Is the business inherently risky? Remember that agricultural, construction and mining businesses have high work-related fatality rates.

  • Is your business type regulated by local, State and/or Federal government?

  • Is the business costly to start?

  • Do you have assets you need to protect? Remember, without limitations on personal liability, personal assets may be used to satisfy business obligations. LLC membership share is not considered an asset; corporate stock is an asset and may be used to satisfy any personal legal judgment against you.

Potential Business Risks and Liabilities Determination

The LLC business structure is an excellent way to protect personal assets from being used to satisfy business debts and obligations. If you are considering starting a business with high risk, that is costly to start or operate, and if you have personal assets that you want protected, the LLC business structure may be right for you.

#2: Cost and Details

In order to form an LLC, you must (at a minimum) complete and file Articles of Organization with the appropriate agency within the State you wish to organize your LLC. Some States may require additional documents be filed; there are some costs associated with filing these documents.

In addition to filing fees, most States require approved Articles of Organization be published in a newspaper or other regularly circulated form of media. Furthermore, some States require an annual fee to update or maintain your LLC registration with the State.

While all States require Articles of Organization, some also require filing an operating agreement, which would require an additional filing fee. Both the Articles of Organization and the operating agreement can be self-prepared; however, if you choose to hire a professional to assist with drafting these documents, your cost will significantly increase. Then, after you have officially organized your LLC, some States require an annual fee to maintain your LLC in active status. This, as with the documents required to organize your LLC, can be self-prepared, or you can choose to hire a professional to prepare the annual filing for a fee.

Cost of Your Business

Another consideration when determining whether LLC is right for your business structure is the cost required to manage your business. These costs will generally be similar to the costs required to manage a sole proprietorship or partnership, but likely less costly than those required to manage a corporation.

As you contemplate these costs, you should decide whether you will handle these matters on your own or hire a professional to do so. If you choose to do so, you will need to balance your time, as well as the cost of your time, with that of hiring a professional to assist you.

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#3: Taxation

An LLC is structured to provide pass through taxation, which means the income your LLC generates is not taxed at the business level. Instead, the income your LLC generates will be passed through to your personal income tax statement. Generally, this is seen as a positive as you do not have to see the income your business generates taxed both at the business level then a second time on a personal level.

However, pass through taxation can also be a negative in some circumstances. Because the LLC has pass through taxation, you are not able to carry equity in your business. Additionally, income generated through an LLC is passed through as it is made; therefore, at the end of each tax year, all of the income your LLC has generated will be passed through to your personal tax statement. In some cases, this may push an individual into a more costly tax bracket or have other negative tax considerations. 

When contrasting the LLC and the “S” corporation, they are essentially the same for tax purposes, resulting in the same tax consequences. However, while the “S” corporation rules limit total investors to 75, there is no member limitation for an LLC.

It is important to understand the potential tax consequences and how those tax consequences will impact your personal tax circumstances before choosing LLC as your business structure.

#4: Financing

As with other non-corporate business structures, the LLC structure does not provide for issuing of stock; this can limit your ability to generate revenue through passive investors. Typically, passive investors will lend money to a business with the expectation that they will be repaid their investment plus an amount of interest. While you can have an unlimited number of members, you typically cannot have passive investors with an LLC. In order to generate investor revenue for a LLC a business owner could either secure loans from investors, or offer membership in the LLC.

An investor loan is generally less liquid than a share of stock and, therefore, more difficult to transfer. Moreover, having a less liquid investment makes the investment more difficult to initially obtain. In order to secure a loan for your LLC, you will most likely need to have excellent credit as well as some collateral to put toward the loan.  

In summary, when looking at whether the LLC business structure will fit your business needs, be sure to consider how you intend to generate revenue to start and initially operate your business because the LLC will limit some investor options.

#5: Other Issues

A final issue that you should consider when considering an LLC as your business structure is where you will conduct your business. Many States have different laws and regulations regarding LLCs. If you intend to transact business in multiple States, you could encounter some inconsistencies with the rules, guidelines and tax treatment your business sees from one State to the next.

If you do intend to conduct business in multiple states be sure you understand the laws, rules and regulations within each State you intend to conduct business, or consult with a business or legal professional who can assist you in that regard.

Conclusion

If you are considering a LLC as your business structure, be sure to review the four checklist items below carefully:

  • Potential Risk

  • Costs

  • Taxation

  • Financing

If you choose to operate your business as an LLC, the simplicity and flexibility will surely enable your new business to be a great success.

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