When To Form An LLC (Limited Liability Company)
Forming a corporation is a big step in a company’s journey. But it’s also a confusing one. After all, there are a variety of options available, such as an LLC (Limited Liability Company), S-Corporation and C-Corporation.
Yet for early-stage companies, the LLC is generally the most popular. Why is this so?
Well, let’s take a look:
Less Paperwork and Procedures: Hey, running a business is time-consuming. If anything, a key reason for why the LLC was formed – which happened during the 1970s – was to make the process less onerous. Keep in mind that for most states you just need to pay a fee, file the articles of organization (which is fairly easy to do and often is done online) and perhaps make annual filings (which are also fairly straightforward).
Now this does not mean you should run your LLC with minimal effort! It’s advisable to put together an operating agreement (especially if you have partners). This sets forth the governance of the LLC, such as with voting, allocation of profits/losses, compensation, authorizations and so on. An operating agreement can be an effective way to allow for stronger management.
Something else: It’s a good idea to, at a minimum, have an attorney review your documents.
Taxes. By default, an LLC is treated as a “pass through entity” — that is, the profits and losses go directly to the owners. For a single-member LLC, this means that preparing a tax return is usually easy. You’ll need to file a Schedule SE for self-employment taxes and also a Schedule C to detail the revenues and deductions.
As for a multi-member LLC, things get more complicated. For example, you will need to file a partnership return (called a 1065) and K-1’s for each member (this shows the allocations of profits, losses and credits).
Regardless, the pass-through feature means that you may be able to deduct losses against other income, which can be a nice benefit. Oh, and if this is not as important, the LLC allows you to elect to be taxed as a C-Corporation or an S-Corporation. In other words, it’s a good idea to compare the different methods to see which provides the maximum tax benefits.
Limited Liability: This is perhaps the biggest attraction of an LLC (keep in mind that you get limited liability protection from a C-Corp and S-Corp too). This means that you can generally protect your personal assets if there is litigation or bankruptcy of your company.
Granted, this is not absolute. If you are grossly negligent, engage in a fraud or commit a crime, then you will likely not get limited liability protection. This is also likely to be the case with signing a lease or getting a loan from a bank (alas, you will probably have to sign a personal guarantee).
But for the most part, limited liability protection is very powerful. Let’s face it, early-stage businesses are very risky.
Estate Planning: An LLC can be placed in a living trust, which can provide for tax benefits and better estate planning. But of course, this is a highly complicated topic and really needs the help of a qualified attorney.
The Drawbacks? No entity is perfect. And yes, the LLC is not ideal for all businesses. Actually, one of the biggest disadvantages is that it is not particularly good for raising money, especially from VCs. It is tough to structure protections in stock (such as priorities with dividends and liquidations), the governnenance tends to be too flexible (there is no board of directors) and even the pass-through tax feature can be a problem (the reason is that VCs may have tax-exempt investors). So if you intend on raising substantial amounts of money, you probably should instead look at the C-Corp. For the most part, the LLC will likely just make things too complicated and may even scare away potential investors.
And Online Legal Services: Yes, there are various companies, like CorpNet, that can streamline the process of making the necessary filings, maintaining ongoing reports and providing for services such as for a registered agent — at affordable rates.