What Is an LLC? | Limited Liability Company Definition
A limited liability company is a specialized business structure that offers several advantages.
It is the preferred corporate classification of small entities and starting businesses due to its simplicity and flexibility.
As an LLC expert with over years of experience in limited liability companies, I will guide you on what an LLC company is, explain to you the different types of LLCs, and the advantages of such a company, and look at how such companies operate.
- An LLC is a business entity that separates the assets of the company from the personal property of the members.
- An LLC enjoys pass-through taxation; the company itself is not taxed, but profits and losses are paid by the members through personal tax returns.
- According to the U.S. Small Business Administration, LLCs represent over 35% of all new business filings nationwide due to their asset protection features.
- Throughout my career, I've seen an equal number of LLCs that can be managed by members or professional managers.
What is an LLC?
An LLC is a type of legal business entity that separates the assets of the company from its members to protect their personal property in case of legal action . According to the U.S. Small Business Administration, this structure has led to a significant increase in LLC registrations, with LLCs now comprising over 35% of all new business filings nationwide.
In case someone sues a limited liability company and wins, they will only recover what the company itself owns, and not what the different LLC owners have as their private properties.
"Although LLCs share the limited liability characteristic with corporations, their ability to offer flow-through taxation to members is a trait typically associated with partnerships, not corporations."
- Jon Morgan, CEO, Co-Founder & Editor-in-Chief of Venture Smarter
Types of LLCs
The main LLC types are as follows:
1. Single-Member LLC
A single-member LLC consists of only one member-owner and is classified as a 'disregarded entity'.
The lone member owns, manages, and operates the business and has the rights to all profits but is responsible for all liabilities the company may incur.
2. Multi-member LLC
A multi-member LLC is owned and operated by several individuals referred to as 'members'.
A multi-member LLC has the option to draft an LLC operating agreement, which all owners are required to sign.
The document outlines the rules, regulations, voting requirements, and ownership distribution of the legal entity.
3. Member-Managed LLC
A member-managed LLC is collectively managed by the company's owners.
For my LLC, the members oversee day-to-day operations, make business decisions, enter into contracts, and supervise financial and legal matters within the company.
4. Manager-Managed LLC
The members of an LLC have the option to employ an independent manager or a managerial service provider to run operations on behalf of the company.
The expertise of a professional and experienced manager is beneficial to the company.
Read More: What is an LLC Managing Partner
How Does Limited Liability Company (LLC) Work?
A limited liability company (LLC) works similarly to a partnership or corporation. When you form an LLC, it can have more than one owner, and they are called members.
Still, unlike corporations and partnerships where two or more partners must agree on how to run the business, LLCs permit single-member companies with no need for an agreement between members.
Limited liability companies are legal entities and can be taxed as a pass-through entity (S corporation, Sole proprietorship, Partnership) or as a C corporation. According to the Internal Revenue Service, approximately 70% of LLCs opt for pass-through taxation to benefit from individual tax rates.
The limited liability feature of LLC is the most common form of business operation to offer protection.
It limits how much an individual member can lose in lawsuits against them by separating owners' personal assets from company property.
LLC members have rights called "membership interests." These rights allow them to vote on how the company is run and how profits and losses are distributed.
The Major Advantages and Disadvantages of an LLC
From my experience, an LLC has several advantages over other business structures, but it also has a few drawbacks.
Advantages of LLC
The main advantages of forming a business entity classified as a limited liability company include personal asset protection, flexibility, and tax advantages.
1. Personal Asset Protection
From my experience running an LLC, the major advantage is personal liability protection since liability belongs solely to the company itself rather than its owners, even as S corporations.
A liability lawsuit against the limited liability company will only affect its assets, not those of any individual owner.
Flexibility is a major advantage because limited liability companies can be structured in many different ways.
For example, the liability of members is limited to their investment only, and the S corporations own all assets.
This means that if an LLC goes bankrupt or experiences a lawsuit, the owner's personal wealth isn't at risk because they're limited liability protection and a separate entity.
3. Profit Distribution
Another advantage of how LLCs operate is that they can choose how to distribute LLC profits.
For my LLC, members who have voting rights get a share of the company's net business income, which is in proportion to their membership interests.
4. Pass-Through Taxation
Limited liability companies are pass-through taxation entities, meaning they don't pay federal income taxes.
For our company, all profits and losses "pass-through" the business to each business owner in proportion to their ownership share.
Disadvantages of LLC
The main disadvantages of forming an LLC include operational costs, state regulations, and transfer of ownership.
1. Cost of LLCs
The main disadvantage is that starting an LLC is more expensive than a sole proprietorship or partnership.
Annual reports and franchise tax fees further contribute to the expenses of the company as per the Internal Revenue Service.
2. State Regulations
LLCs are subject to fees, restrictions, and legal requirements which vary from state to state. Professionally run LLCs require additional documentation such as licenses or special permits.
Since most LLCs are operated, managed, and co-owned by the members, any transfer of interest or withdrawal must be approved by a majority, making the process more complex.
Is LLC Good for Small Businesses?
An LLC is good for small businesses because it is complex and expensive to establish a corporation.
What Are the Financial Benefits of an LLC?
The financial benefits of an LLC include personal asset protection and pass-through taxation. The members' personal properties are protected, and they are not subject to double taxation.
Who Runs LLCs?
LLCs are run by an individual, a group, or a legal entity. Limited liability companies can be managed by a member, a hired expert, or a managing company.
What is an LLC License?
An LLC license is a legal document that indicates the company is a registered limited liability company in the state it is located in.