This is a guest post by Arjun Mahadevan of StartPack, a “company-as-a-Service” platform to form and launch your US business from anywhere.
Picking the right legal structure can be one of the most daunting steps in starting a business. You’ve got your idea, and you’re ready to start serving clients, but you need to make sure you’ve got all the right things in place legally to move forward. It seems simple until you start looking at the different structures and questioning which one to choose. Should you keep things simple as a sole proprietor, or do you need a corporation?
One of the best ways to find a middle ground and benefit from your legal structure is to choose an LLC. In this post, we’ll explain exactly what an LLC is, explore the benefits and disadvantages of an LLC, and help you decide whether or not an LLC is the right business structure for you.
What Is an LLC?
An LLC is a limited liability company, which means that the business owner(s) have some legal distance from the business itself. That means that should the LLC get into a legal battle (like getting sued) or financial difficulty, the owner’s assets are protected.
This makes an LLC one of the best and most popular business structures, especially for small businesses. An LLC is a little different from the other four major business structures (sole proprietor, partnership, S-Corp, C-Corp) because it combines the best features of those structures with the LLC’s added protections and benefits.
So, if it’s so popular, why doesn’t everyone form an LLC? An LLC isn’t right for everyone, so let’s take a closer look at the benefits and disadvantages of an LLC.
What Are the Benefits of an LLC?
There are five main benefits of forming an LLC.
1. Member (Owner) Asset Protection
The main reason people choose to form an LLC is for the liability protection it offers. “Limited liability” means that the owner(s) of the LLC (called “members”) are not personally responsible for any financial debts or problems the LLC encounters. That means that if something happens that your business would struggle to recover from financially, you cannot lose your home, your savings, or any other assets you have.
2. Protection Without Complexity: Pass-Through Taxation
Another great reason to choose an LLC is that it offers limited liability without making your business unnecessarily complicated. For example, you can form a single-member LLC instead of a sole proprietorship, which would give you limited liability, though you would still file your taxes as if you were a sole proprietor. LLCs are viewed as “pass-through entities,” which means they are not taxed in their own right on a federal level.
3. Protection Without Complexity: Administration
LLCs also offer limited liability without the administrative complexity of being a corporation, such as boards and shareholder meetings, directors, and so on. Even when you are running a corporation with few people, you still have to create and keep all these documents.
4. You Can Choose How You’re Taxed
LLCs can be taxed in the same way as any of the other business structures. When you form an LLC, you can elect to be taxed in the way that gives you the most benefits for your circumstances. As we mentioned above, you could continue to be taxed as a sole proprietorship if that works best for you. However, if you’re making a significant amount, it can work in your favor to be taxed as a corporation.
5. An LLC Makes Your Business Trustworthy
Depending on your industry, goods, and services, some customers will find you more trustworthy as an LLC than if you’re operating as a sole proprietor or partnership. It shows that you’re serious and can reassure customers that you’re not going to disappear overnight.
What Are the Disadvantages of an LLC?
An LLC isn’t all upside, however. There are two big disadvantages to using an LLC structure for your business.
1. An LLC May Be More Expensive
In most states, it costs very little to get a business license and start operating as a sole proprietor. However, LLCs often cost more to establish and maintain. Many states have an annual fee or tax for LLCs, which is around $100 in most states, though it’s $800 in California, and some charge additional fees for profitable LLCs. Again, California is the most costly state to be in, with fees for LLCs making over $250,000 ranging from $900 to $12,000 depending on how much income you make in California. This won’t be a concern for most, and the highest fees are for businesses making over $1 million, but it’s something to research and keep in mind.
2. LLCs Don’t Work Well If You Plan to Go Public or Find Angel Investors
LLCs work amazingly well on a personal level, but if you plan for your business to have meteoric growth, perhaps through angel investors or venture capitalists, it will likely be in your best interest to form as a corporation. If you plan for your business to go public relatively soon (so your shares can be bought on the stock market), you should also think about incorporating.
Do You Even Need an LLC?
Forming an LLC isn’t that complicated, but there are more responsibilities than if you were to form a sole proprietorship or partnership. That may lead you to wonder if you really need an LLC, especially if you’re just starting out. Here are a few questions you need to answer to find out if an LLC is right for you:
Am I working solo, or with others?
If you’re going to be working with a partner or multiple partners, an LLC will always be best. It will take you thirty seconds to find a partnership horror story online, and you definitely don’t want to become one. Sure, some people really can work together well for decades, but why risk it? You can have all the same benefits as a partnership with an LLC, and the LLC will mean you can’t be liable if your business partner makes a bad decision (and vice versa).
Am I at risk of being sued?
These days, getting caught up in a lawsuit isn’t as uncommon as you might think, especially once your business finds success. Think seriously about whether someone could come after your business—it’s not likely, but it can happen. If you have a physical store, you give legal, business, health, or financial advice, or you work on people’s most valuable assets, it’s almost certainly worth forming an LLC.
There’s one caveat here: Some states won’t allow you to do this if you’re a licensed professional. In that case, consider forming a professional limited liability company or corporation instead.
Is this a side hustle?
If you are planning to only make a little money on the side, then you may not need to form an LLC just yet, especially if the fees in your state will eat significantly into your profits.
Forming an LLC will be the right decision for most since it protects personal assets. You only need to think twice if you might be better off forming a corporation now, or if you live in a state where maintaining an LLC is costly, and you don’t forecast your income to be large for the first year or two of your business. Remember, you can always form an LLC later on, and if you’re ever in doubt, consult a local accountant.
Learn More about LLCs
Check out the resources below to learn more about LLCs and the necessary groundwork for starting a business:
AP 0542: Why Did You Start An LLC? – Smart Passive Income
AP 0329: When Do I Need to Set Up an LLC? – Smart Passive Income
The Details Behind Starting an LLC For Your Small Business – Part 1
The Details Behind Starting an LLC For Your Small Business – Part 2
How to Start a Business Built to Endure – Smart Passive Income