What is a Limited Liability Company (LLC)? Simply put, it is a form of business organization where you can set up separate entities with reduced risk compared to running businesses by yourself.
It is not the same as traditional partnerships or corporations but instead falls somewhere between. There are pros and cons of setting up an LLC which you should be aware of before making your decision.
What is an LLC?
As mentioned earlier, LLCs are not the same as partnerships and corporations. Here are some things to know when you want to form an LLC:
An LLC can be a sole proprietorship or partnership where two owners exist. If there is only one owner of an LLC, then it will be treated as a disregarded entity (a pass-through tax entity) for tax purposes.
If an LLC is taxed as a partnership, any income or loss generated will be passed through to the owners of the LLC and reported on their personal returns.
However, if the LLC is taxed as a c-corporation or s-corporation, then the income or loss will still be passed through to the owners, but it will also be taxed once again at the individual level.
LLCs are generally flexible. Unlike corporations, LLCs may allow for different ownership structures, such as allowing members to have unequal voting rights and unequal distribution of profits.
Additionally, in the case of an LLC taxed as a partnership, you may use different allocation methods to determine how income or loss is allocated.
What Types of Businesses Should Choose an LLC?
As mentioned, business structures are flexible. There are many ways to form an LLC, and it can be under any structure such as:
Businesses – If you have a small business and want to limit your personal liability, then an LLC is one solution (although it won't eliminate all possible forms of liability). It will not prevent you from being sued for some form of wrongdoing. However, it will help protect your personal assets.
Businesses with Limited Capital – Businesses with limited capital may want to consider an LLC as a form of business organization since it is relatively easy to set up and less expensive than other forms of business such as corporations or S-corporations.
Moreover, if the LLC is taxed as a disregarded entity, then you won't need to file separate tax returns for the business.
Businesses with Many Owners – Businesses such as general partnerships and limited partnerships may want to consider an LLC since it allows for multiple owners. This may help protect partners with personal liability.
LLCs are also popular among new businesses. You can keep your start-up costs low since there are fewer formalities to follow.
It is easier for an LLC to raise funds as compared to a corporation due to the flexible ownership structure and ease of the process, which gives it a distinct advantage over other forms of business organizations.
It's difficult to narrow down the types of businesses that can be LLCs. Because it is a flexible form of business structure, any type of company may use an LLC, including:
- Consulting firms
- Marketing and advertising agencies
- IT firms
- Contractors and Builders
- Fitness studios
Advantages of an LLC
A Limited Liability Company has some benefits that are similar with both corporations and partnerships.
Personal Asset Protection
Because it is considered a separate entity from the LLC owner, limited liability protection is one of the biggest advantages you will have when you form an LLC.
This means that the business itself is its own legal entity from the LLC members, so if you are sued, or something goes wrong with your company, only the assets of the company are at risk.
It does not mean you can conduct any type of activity without being held accountable - if you personally sign for a loan, accept the responsibility on behalf of the company, commit insurance fraud or commit any other illegal activity such as not paying off our business debts, then you can be held legally accountable.
However, this does not mean that the asset protection is useless - creditors and injured parties cannot seize personal assets such as your house or car when they chase after money owed to them by your company's business debts.
Legal and Tax Advantages
Another advantage of running your business as a Limited Liability Company is that it can help you avoid double taxation.
In other words, it is subject to pass-through taxation - the problem with traditional S-corporation or C-corporation and limited partnerships are that owners are taxed twice on earnings: first, at corporate tax rates and then again on personal income taxes.
With an LLC, you pay LLC taxes only once because the company itself does not pay income taxes, but you pay self-employment taxes.
However, you must remember that any money earned by the company is also subject to personal income tax once it is distributed as dividends, so this isn't really a big advantage.
Limited Liability Companies are very easy to set up and operate compared to other corporations or partnerships where there are complex requirements related to the number of shareholders, voting rights, etc.
People who are starting a business can do it on their own, which is much easier than working with other partners or investors to set up a formal corporation.
Furthermore, if you are worried about liability, keeping your business as an LLC means that you can always convert to a standard corporation after your business becomes well-established.
Flexible Management Structure
An LLC has another major benefit - it allows the owners (called members) to manage their business independently without having to work directly with other shareholders or partners.
The agreement between the LLC owners also does not have to be complex since an LLC operates as a Sole Proprietorship, and you can structure it in any way that works best for you and your business.
This is one of the main benefits of running your business as an LLC. A new corporation or partnership will have difficulty getting new customers because they are not yet established, but with an LLC, you don't have this problem.
Customers automatically recognize that an LLC is less risky since it is legally separate from its owners. Moreover, if your business grows widely. Lastly, an LLC is more credible in the eyes of customers and suppliers.
Credibility increases for your company when you operate with limited liability since it is viewed as a separate business entity from its owners.
Customers are also less likely to sue companies that are structured as Limited Liability Companies because they cannot go after the personal assets of the LLC owners, which makes it more difficult for them to collect a judgment against your company.
To summarize, running your business as an LLC has many pros, including limited personal responsibility, simpler tax-filing requirements, operational flexibility, and credibility among customers and suppliers.
However, there are also some cons to being an LLC.
Disadvantages of an LLC
There are some disadvantages to creating an LLC.
Running your business structure like an LLC means higher fees and paperwork compared to working alone or with one partner.
You will be dealing with lawyers, accounting professionals, and other high-cost specialists much more frequently for their professional services in the beginning when you are setting up your LLC, so this is one of the disadvantages.
Although an LLC does not have the same level of tax benefits as a corporation, there are no major disadvantages in choosing this structure.
It is simply a matter of being neutral and whether you want to take advantage of the tax benefits of a corporation or the liability protection and operational flexibility that you get with an LLC.
LLCs are not as transferable compared to other corporations. If you want to sell your LLC, it can be difficult to find a buyer.
This is because of the limited liability structure, which means that nobody will buy an LLC with just one owner since there is no legal separation between the business and the owner if they run into problems.
An LLC is not as attractive for investors as a corporation. This means that it will be difficult to attract outside investments for your company, and you might be limited to operating with only one owner as a sole proprietorship.
Why Is LLC So Important?
LLCs are important because they protect your personal assets at stake. This is because of the limited liability that the LLC provides.
And it's not just for investors, entrepreneurs also need this so other companies won't sue their business if something goes wrong with their products or services, keeping them protected from any personal responsibility.
What Does an LLC Protect You From?
An LLC offers you limited liability protection if something goes wrong with the company's business operations.
This means that liability falls on the business and its assets, not on you as an owner or on your personal property.
To conclude, an LLC is an easy-to-use legal entity for a new business that has become a popular choice among entrepreneurs or small business owners who form their own small businesses easily without going through all the complicated steps and corporate paperwork required by other businesses.
It is also a structure that will help protect your own assets from any personal liability.
It is better to consult experts when starting an LLC because the structure of your business entity will affect other aspects such as taxation and liability.