When starting a new business, it is vital to consider how you want to protect your personal and business assets. An LLC is one of the most popular business entity types that will help better protect yourself when your startup has a high failure risk.
Forming an LLC is the least complex business structure that has many advantages, but it is not for everyone. Follow this guide on forming an LLC to help you decide if an LLC is the right choice for your startup.
What is a Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a hybrid business structure that has characteristics of a sole proprietorship, general partnership, and corporation. It has the tax advantages of the non-corporation entities and limited liability protection of corporations. Depending on the state, you will be required to have an Operating Agreement that delineates some key aspects of the business. An LLC can get a tax identification number, open a bank account, and perform business under its own name.
What are the Advantages of Forming an LLC
There are many advantages to an LLC compared to other business entities:
- Legal protection - Compared to a sole proprietorship or partnership, an LLC will protect your personal assets and also shield you against being personally responsible for the LLC’s debts or lawsuits.
- Credibility - An LLC is recognized by partners, suppliers, and lenders as more favorable. The business name will let customers take your business more seriously.
- Simplicity - LLCs require less paperwork and formal meetings, roles, and record-keeping procedures compared to corporations.
- Management - There are no directors or shareholders to maintain.
- Distribution - LLCs are not required to distribute profits equally according to the number and types of shares held. Ownership and profit distribution percentages can be different.
What are the Disadvantages of Forming an LLC
There are also downsides to LLCs:
- Taxation - If an LLC is taxed as a pass-through entity, individual owners will need to pay taxes on their share of the profit and loss regardless of whether they received a cash disbursement from the company. This may cause an undue cash flow burden on the owners.
- Maintenance Costs - Every year, an LLC will normally need to pay an annual fee to maintain the company status. This increases the cost of having an LLC.
Even though there are disadvantages, the benefits far outweigh the costs.
Should You File a DBA or Form an LLC
If you’re a small business, sole proprietorship, or partnership, it’s best to form an LLC. It’s time to ditch the "doing business as" (DBA) and cough up the cash for an LLC for the legitimacy and benefits of protection. In some cases, it may even be cheaper to get an LLC than a DBA!
When Should You Not Form an LLC?
- You aren’t selling any products or services now or in the foreseeable future.
- You’re just testing the waters and seeing what services or products might be a viable business to pursue.
- You don’t have any clients or customers built up.
- Your company isn’t visible, online or offline.
When Should You Form an LLC
- You are selling your product or service on the regular.
- You have regular and repeat clients or customers.
- You would like your business to have its own liabilities, assets, and ability to open business bank accounts, separate from your personal accounts.
- You are hiring independent contractors or employees.
- You’re starting a business with more than one person. By default, this is a partnership, but with an LLC, you both (if there are more than two, you all) become ‘members’ of the LLC protecting your ownership and longevity of the business.
What Are the Steps to Form a New LLC
An LLC can be formed in 6 steps:
- Find your location
- Name your LLC
- Choose a registered agent service
- File Articles of Organization
- Prepare an Operating Agreement
- Apply for a Federal Tax ID (FEIN)
1. Pick Your State
Location, location, location! You might be thinking, does my state matter? Short answer, yes it does.
These states are often hailed as business-friendly bases for registering LLCs.
Delaware - In the state of Delaware, LLC formation statutes are very accommodating and progressive with low filing fees. There are no residency mandates for registering your LLC and limited reporting and disclosure requirements. Delaware has a special business court, the Delaware Court of Chancery, with experience handling commercial disputes and interpreting business laws that is known for its fast and efficient services. Here are 4 steps to form your Delaware LLC.
Nevada - This state is a business-friendly location with laws that are favorable to corporate entities and their management. In Nevada, there is no corporate income, personal income, or franchise taxes. Nevada also offers confidentiality to LLC owners permitting them to remain unnamed in public registration filings. For compliance purposes, Operating Agreements and organizational or annual meetings are not mandated. Here are 6 steps to form your LLC in Nevada.
2. Name Your LLC
The name that you choose must follow your state’s LLC laws.
- Search if your LLC name is available in the state that you’re registering it in and that no duplicates or similar names exist. You can search your LLC name on the individual state’s Secretary of State website.
- Reserve your business name (optional).
- Decide if your business name will be trademarked. If you wish to have a trademark, it’s best to come up with a unique and non-descriptive name for your business. The best recommendation is to speak to a patent and trademark lawyer.
TIP: Choose a unique name that is distinct, easy to remember, easy to spell, and simple to pronounce. Select an LLC name that represents your service and distinguishes your business from competitors.
3. Choose a Registered Agent Service
LLCs must have a registered agent in each state where they are registered to do business. Every state requires an LLC to have a designated registered agent and must provide the agent’s name and address on state documents.
What is a Registered Agent? A registered agent is a third-party entity or individual that is responsible for the correspondence, processing, and receiving of government notices, lawsuits, subpoenas, and other official documents on behalf of the LLC. They help with keeping backup copies of legal documents, signing articles to be filed, and staying up-to-update on compliance with state requirements.
Requirements vary in each state and registered agents must follow these general rules:
- Have a physical office in the state where your business is registered
- Be available at the physical street address during normal business hours to receive legal documents
Why Do You Need a Registered Agent? A designated registered agent is required for any corporation, LLC, or Limited Partnership to accept government official documents on their behalf. The state in which your business is registered will need to know there is a point of contact for your business at all times.
Some states allow you to designate yourself as the registered agent for your company. This is a cost-effective way for a startup. However, you should note that your name and contact information will become public information posted on the website for everyone to see.
If you want to keep your personal information private, it is recommended to use a third-party commercial registered agent service. Besides providing a degree of privacy, commercial registered agents also offer the following benefits:
- Flexible - You will not have to make yourself available during all business hours to received official documents.
- Peace of Mind - They will help you stay on top of legislative changes, due dates, and disparate laws of different states.
4. File Articles of Organization
To create an LLC, many states require the Articles of Organization to be filed with the Secretary of State. Processing time ranges from days to weeks with expedited options available.
Completing the form itself is simple. You can either hire a lawyer, an online legal filing service like LegalZoom, or do it yourself by downloading the appropriate form from the Secretary of State website. Filing fees will apply.
After your LLC documents are filed and approved, the state will issue a formal certificate that confirms your LLC is registered and formed. Once you receive your business certificate, you can then obtain a tax ID number, apply for any required business licenses, and open a business bank account.
5. Prepare an Operating Agreement
An Operating Agreement outlines ownership, member responsibilities, and operating procedures in an LLC. While it is not required in all states, it is still recommended as it provides a number of safeguards and adds more protective measures in case of disputes or lawsuits. Read more about why an operating agreement is important.
An operating agreement should at least have the following sections:
- Organization - Covers the structure of ownership, members, and the creation of the company
- Management and Voting - Addresses how the company is managed and how members will vote
- Capital Contributions - Outlines how additional money will be raised by members
- Distributions - Breaks down how profits and losses will be shared among members, such as money or physical property
- Membership Changes - Describes the process for adding or removing members as well as the transfer of ownership
- Dissolution - Explains the circumstances under which the company must be dissolved
6. Apply for a Federal Tax ID (FEIN)
Every business is required to file and obtain a Federal Tax ID to use for filing taxes, opening bank accounts, or hiring employees. A Federal Tax Identification Number (also known as a 95 Number, EIN - Employer Identification Number, or Tax ID Number) is a nine-digit number issued by the IRS. You can apply for the SS-4 online and obtain an EIN fast. You can also follow this guide on the 4 steps to apply for an EIN.
In order to apply for the EIN online, the business must be based in the United States or U.S. Territories, and the person must have a Taxpayer Identification Number (ITIN) or social security number (SSN). If you don't have one, then you would need to file by mail.
An LLC is one of the most popular business entity types you can use to form your business. Forming an LLC is easy, fast, inexpensive, and can be simple in structure depending on the Operating Agreement. Compared to a sole proprietorship or partnership, an LLC offers more legal protection from lawsuits and liability claims. Compared to a corporation, it has fewer legal and corporate formalities, leading to simpler and easier maintenance. Additionally, if your business is at high risk for failure (which all new startups fall under), then an LLC will help better protect your personal assets.
At a minimum, an LLC is recommended over a sole proprietorship or partnership. However, if you plan to have outside investors or you are looking for venture capital, you may want to consider forming a corporation right at the start.
You’re Not Done Yet
Although, you’ve gotten most of the bulk of the work done to form your LLC there is maintenance required to continue your business operations. Here’s what to do AFTER forming your LLC.