If you’re considering forming a limited liability company (LLC) for your business, but you’re wondering how exactly it would affect your company, you’re not the only one.
One of the most common questions we hear from our readers is what the pros and cons of the LLC are. With that in mind, we put together this article to help you figure out whether the LLC is the right business structure for your company, or if you should rethink your plans to form one.
While the LLC is certainly a popular business entity, that doesn’t mean it’s all positives and no negatives. Let’s discuss how an LLC can help your company reach its goals, and also how it might hold you back.
What Is an LLC?
The limited liability company is a business owned and operated by one or more people, who are often referred to as “members” of the LLC.
The LLC is a hybrid business structure that combines the casual flexibility of sole proprietorships and general partnerships with the limited liability protection of a corporation.
The main reason for the LLC’s popularity is because it provides personal asset protection, but there are several other reasons that the LLC is such a widely used business structure. Let’s get started by taking a look at some of the biggest advantages that come with forming an LLC.
Advantages of the LLC
Limited Liability Protection
Let’s start with the crown jewel of the limited liability company, which is the personal asset protection it provides. Similar to a corporation, the LLC protects your personal assets in case of a lawsuit against your business.
This means that if the suit ends with a judgment against your business, or a settlement, your creditors can only come after your business assets, while your personal car, house, bank accounts, etc. are protected.
Simple Formation, Simple Maintenance
Especially compared to more formal business structures like the corporation, setting up and operating a limited liability company is quite simple. Each state has its own requirements for LLCs that tend to vary a bit, but for the most part you only need to include some basic info about your business to form it.
Furthermore, it’s not tough to maintain an LLC either, as in most states you just need to file your annual report in a timely manner.
LLC owners are actually given a choice of how they want their company to be taxed, and they overwhelmingly choose the taxation model used by general partnerships. With this “pass-through” form of taxation, business income is not taxed on the corporate level.
Instead, it passes through the LLC itself to its owners, who then claim any profits or losses from the LLC on their personal tax returns. This helps the business avoid the double taxation model of most corporations, in which the same money is taxed twice ― first on the corporate level, then again on the individual level.
Options for Managerial Roles
Would you prefer for your limited liability company’s ownership group to take care of the daily managerial role? Or would you rather hire an outside manager who does not have an ownership stake to handle the day-to-day operations of your business?
With an LLC, you’re allowed to choose between member-management and manager-management, and you are also able to switch between the two styles at any time, as long as you inform the state of the change to your management structure.
Credibility and Professionalism
Even if you own and operate a one-person business that’s based out of your home, there’s a massive difference between operating as a sole proprietor and operating as a single-member limited liability company (SMLLC).
In addition to the factors we’ve already discussed, like limited liability protection, the one-person business gains a tremendous amount of credibility and legitimacy from forming an SMLLC.
It makes a huge difference to customer perception when you’re operating a company under a legal business name as opposed to your own personal name.
With an LLC, you’re allowed to choose how you want to split profits among your owners, and you can also weigh owners’ votes differently.
These options are tremendously helpful if you want to create an uneven split due to different owners’ varying degrees of investment and/or involvement in your company.
Disadvantages of the LLC
It’s not all positives for a limited liability company though. There are several drawbacks that ― depending on the nature of your business ― may be enough to change your mind regarding forming an LLC. Let’s discuss what these disadvantages are, and how they might affect your company.
The Limitations of Personal Asset Protection
If you don’t maintain your LLC exactly as you’re supposed to, you could find that your limited liability protection has some limits of its own.
Specifically, if you don’t keep your business assets strictly separate from your personal assets, a court could pierce your corporate veil, which is a fancy way of saying that you’d lose your personal asset protection. This could also occur if you use your LLC to commit fraud, or if you accrue any outstanding business debts that you’re unable to pay off.
Each state has its own set of rules and regulations for limited liability companies, because this business type is regulated at the state level, rather than on a nationwide scale. In addition, it wasn’t until 1996 that all 50 states recognized the LLC as a legal business structure.
Because of this, there isn’t much precedent in the American court system regarding how these companies should be treated legally, which can be an issue for lawsuits involving LLCs.
Lack of Outside Investments
It’s usually quite difficult for LLCs to attract significant outside investments, in large part due to the fact that an LLC can’t sell ownership shares like corporations do. In addition, it’s not easy to attract venture capital to LLCs either, because pass-through entities are often unappealing to venture capitalists for a variety of reasons.
LLC owners are considered to be self-employed, which can result in some serious self-employment tax burdens.
Just like every freelance and contract worker in America ― and all other self-employed people ― an LLC owner is required to pay a self-employment tax of 15.3%, which is the combined employer and employee share of both Social Security and Medicare.
Forming an LLC
If you’ve decided that the advantages of forming an LLC would outweigh the disadvantages for your business, it’s time to shift your attention toward the formation process itself. The limited liability company formation process isn’t particularly complex, but it is important that you complete each step correctly.
To form a limited liability company, you will need to fill out a document known in most states as the articles of organization. This is a relatively simple form that includes some basic information about your company, including the name of your business, the name and address of your registered agent, the identities of your LLC’s owners/members, and the name of your LLC organizer.
If you choose the manager-management structure, you should also indicate your manager’s name.
When you’re ready to fill out the articles of organization, you can usually find a template for this document on your state’s Secretary of State website. You can also simply create your own from scratch if you would prefer. Either way, the DIY option is quite popular for limited liability company formations, but it’s definitely not your only option.
You could hire a business attorney to prepare and file your articles of organization, which gives you a high degree of peace of mind, as you can be quite confident that every step is completed correctly. On the other hand, lawyers can charge very high rates for LLC formations, and their expertise may not be worth the cost due to the LLC’s ease of setup.
Our favorite option is to hire a business formation service to help form your company. There are plenty of reputable companies offering this service, and their rates are usually much more affordable than a business attorney, especially considering the tight startup budgets many LLCs start off with.
If you’re interested in using an online business formation service, you can take a look at our guide to the best LLC formation services, or if you’d just like a quick overview, here’s a sneak peek at our top three:
- Zen Business ($39): Zen Business beats Northwest’s price tag, while also offering a free year of registered agent service. While Zen Business doesn’t have the same level of customization for their customer service as Northwest does, they do have thousands of fantastic customer reviews available online, which can be quite the advantage depending on your preferences. (Read our full review)
- Northwest Registered Agent ($225): For the price of $225, Northwest will form your LLC and include a full year of their premium registered agent service. They also have next-level personalized customer support that makes Northwest one of our favorite companies in this industry. (Read our full review)
- LegalZoom ($79): LegalZoom can’t match Northwest or Zen Business when it comes to value overall, and they don’t include any registered agent service with their LLC formation packages either. However, LegalZoom has a massive customer volume and impressive brand power, so if you want to use the most popular service available, LegalZoom is worth a look. (Read our full review)
How Expensive Is LLC Formation?
Formation fees for limited liability companies vary considerably from state to state. In some states, you can form an LLC for as little as $50 or even less, but other states charge much higher rates that reach several hundred dollars.
Of course, if you hire an attorney or an LLC formation service to help you with the formation process, you will need to add that expense to your state fee to figure out your total cost.
Too often, we see the conversation about limited liability companies focus solely on the positives. We think it’s just as important to illustrate the negative aspects of the LLC as a business structure so that you can get the full picture of how this entity would affect your company.
For most businesses, we do think that the advantages considerably outweigh the disadvantages. It’s not too expensive to form or maintain an LLC, and the amount of flexibility this business structure provides truly sets it apart from other entity options.
Whether you end up forming an LLC or not, we hope this article helped clear up any misconceptions you may have had about limited liability companies.