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When starting a business, one of the most important concerns is how it is structured from a legal standpoint. Since this choice can have significant tax and personal liability implications, taking time to make the best decision at the beginning is very important. For most new and small businesses, the preferred entity choice is often a Limited Liability Company (LLC). But before talking about why that is, it’s beneficial to understand some of the other options available.
Sole Proprietorships
A sole proprietorship is the simplest structure to use when starting a business. This is because it is an unincorporated entity both owned and run by one individual with no distinction between the business and the owner. While the owner is entitled to all profits, he or she is also personally responsible for all your business’s debts, losses and liabilities. That being the case, it should be noted that a sole proprietorship has the potential to expose a business owner to substantial personal risks down the line.
Partnerships
As the name indicates, a partnership is comprised of two or more people sharing ownership of the business. Under this model, each partner participates in all aspects of the business and shares in both profits and losses. Generally (and depending on the type of partnership formed), partners are personally responsible for all of the business’s debts, losses and liabilities.
Corporations
A corporation is a distinct legal entity controlled by a board of directors and owned by shareholders. One of the advantages to forming a corporation is that the business entity (and not the shareholders) is held legally liable for the actions and debts the business incurs. However, corporations are highly complex and are subject to costly administrative fees, complicated tax structures and numerous legal requirements. That being the case, corporations are often better suited to large companies with multiple employees.
Limited Liability Companies
An LLC as a legal entity is a relatively recent innovation. It’s unique (and often advantageous) in that it provides its owners (known as “members”) with limited liability for the obligations of the LLC (much like a corporation) yet offers the flexibility and many of the tax advantages of a partnership. Under the most common LLC model, all profits and losses are passed through the business to each member and members then report those profits and losses on their personal federal tax returns, just like the owners of a partnership would.
Some of the greatest advantages of an LLC include simplified record keeping, customizable profit sharing and protection for members from certain business decisions or actions.
In most circumstances, if the LLC incurs debt or is sued, members' personal assets are exempt. However, it is important to keep in mind that the limited liability protections of an LLC are not necessarily “unlimited.” Certain conduct, including wrongful acts of members or their employees, could allow for members to be held personally accountable.
Generally, in order to form an LLC, several steps are required. First, the business needs a name that (i) contains an indication that it is an LLC (i.e., “My Business, LLC”), (ii) is different from another existing LLC in the state, and (iii) doesn’t include any particular words restricted by the state. Second, articles of organization will need to be filed with the state which include information about the business, such as its name, address, registered agent and the names of its members. The final step in the LLC formation process is to create an operating agreement. An operating agreement provides clear and specific guidelines regarding finances, organization, member rights and responsibilities and other regulations for smooth operation.
Of course, once your LLC documents have been prepared and formed, it will be necessary to ensure that all business licenses and permits have been obtained before actually conducting any business.
Should you be interested in any further information or assistance regarding LLCs or any other business entity, please do not hesitate to contact us.