Limited liability companies (LLCs) have become a popular way for investors to structure their holdings, beating out the formerly more popular limited partnership.
The beauty of an LLC is its flexibility. From families pooling their money together to Fortune 500 corporations that have subsidiaries, there are many ways to take advantage of the benefits of an LLC.
Learn what LLCs are, why investors use them, and some of the factors you may want to take into consideration before you form an LLC or invest in one.
How Do Limited Liability Companies Work?
A limited liability company is a form of business structure or arrangement that provides a lot of flexibility when it comes to ownership, taxation, and profits. As implied by its name, this structure limits the personal liability of its members for the company's debts.
Forming an LLC is relatively simple: The member or members choose a name and then file articles of organization with their state of choice, for a fee.
While you can file your LLC in your state of residence, you also have the option of filing a Delaware LLC or Nevada LLC. Limited liability companies formed in these states may be able to take advantage of benefits such as fewer taxes and more anonymity.
Benefits of Using a Limited Liability Company
An LLC is a special legal structure that combines the benefits of a corporation and a partnership. Some of these benefits and advantages include:
Choose Your Tax Status
An LLC can choose whether it's taxed as a corporation or not. That is, you can decide to have the company pay taxes on its earnings as a regular stock corporation would, or you can elect to have it prepare K-1 statements for each investor showing their portion of the profits and losses, which they then declare on their personal income tax filings.
Can Be Member-Run or Manager-Run
Instead of shareholders, LLCs have members. An LLC can be either “member-managed” or “manager-managed." In a member-managed limited liability company, all owners have a say in day-to-day decisions. In a manager-managed limited liability company, the members select managers to run the business, and these managers handle the daily work, often for salary and wages.
Flexible Profit and Loss Allocation
Profits and losses can be divided in virtually any way that is compatible with tax law, unlike with a corporation where everything has to be divided pro-rata. If you and your family formed an LLC to start a restaurant, you could write the contract that governed the business (known as the “operating agreement”) to meet your needs, no matter how complex.
Limited Liability for All Investors
Unlike a limited partnership, where the managers, or general partners, have personal liability for the business debts and liabilities, in a limited liability company, no one is personally on the hook—unless they agree to be, in a contract. One such example would be a commercial bank loan that requires a personal guarantee from any owner of more than 20% of the LLC equity.
Fewer Paperwork Requirements
A stock corporation is generally required to file regular paperwork with the state in which the business is formed, as well as publish annual reports and have regular board of directors meetings. A limited liability company, on the other hand, requires virtually no upkeep in comparison. Meetings can be as formal or informal as you wish, as long as everything is properly documented.
Cheap Formation Costs
Limited liability companies can be established for very little money. A simple LLC will usually cost less than $300 to create. In fact, you can even use one of the several online legal services companies to file your paperwork and provide fill-in-the-blank operating agreements and company membership certificates.
Factors to Consider
LLCs are not right for every situation. Consider whether your single-member small business might be better or more affordably served by being a sole proprietorship, which does not require start-up or annual fees.
Limited liability companies require you to keep careful records, and you must separate the company's finances from your personal finances. This may require a separate bank account. You may also be required to pay an annual tax; in Delaware, for example, the annual tax is $300 per year.
You also may be liable for self-employment taxes with an LLC, which you would not have to pay if you chose to be taxed as a corporation.
Finally, LLCs are not permanent. Depending on your state and your operating agreement, an LLC may be subject to dissolution if a member departs or dies. You may be able to combat this with your operating agreement.
You may also want to check out a legal structure known as a Limited Liability Limited Partnership, or LLLP, which is a bit different—it has some of the qualities of a limited partnership, but with limited liability, too.