22 Apr Why You Should Use an LLC and How You Form One

Today we begin our series of blogs concerning limited liability companies—why you want them, how you form them, and how to you make your LLC bullet proof.  We first explore why you should use an LLC and how you form an LLC.

Protect Your Personal Assets From Business Liability

Entrepreneurship is an exciting endeavor, one that many individuals are exploring in 2018.  It’s exhilarating and risky.  One way to make your new gig is a little less risky is to use an ownership entity that protects your personal assets from any business liability your company may incur during the course of its existence.  As a business owner, you have a number of options available to you—sole proprietorship, partnership, limited liability company, corporation.  Which one is best for you?

Selecting an Ownership Entity

Your first consideration in protecting your personal assets from liability is to choose a company ownership vehicle so that your business liability is kept separate and does not subject you and your family to personal liability.  This protects your personal assets from being up for grabs if and when your company is sued.

But how do you choose?  Partnerships, corporations and limited liability companies all have different filing, operational and tax requirements.  You need to ask yourself: What is the purpose of the proposed investment?   Long-term/retirement, steady income or short-term/sale?  Are you going into business solo or with several investors?  Do you want to manage?  Do you want to delegate management?

Why You Should Use an LLC

The LLC is typically the way to go for the solo/small group business ventures.  Why?  Because LLCs provide the most flexibility, with the least amount of formality, and the most protection of all the entity forms with maximum control.  LLCs combine the liability protection of a corporation with the tax treatment of a partnership.

Unlike corporations, LLCs have no meeting requirements; there is no need to take minutes or have formal meetings; it is easy to manage yourself (this is a “member-managed LLC”); and just as easy to delegate management within the LLC, but allow the remaining investors the right to participate in major decisions affecting the investment (this is called a “manager-managed LLC”).

Why You Should Use an LLC — Less Formality

It is so much easier to maintain the corporate formalities for an LLC than it is to maintain the corporate formalities of a corporation.  This is critical, because in order to protect your personal assets from the liability of your business and prevent the “piercing” of the corporate veil, you must meet the corporate formalities to prove to a court that you and your business are not one in the same (and thus should not both be liable).

The corporate formalities of an LLC are so much easier to maintain than a corporation’s.  For example, for a corporation, you must draft bylaws; have annual meetings; send notification of the annual meetings; take and maintain meeting notes, minutes and resolutions; and elect directors.  For LLCs, there is no need to have annual meetings; no need for bylaws; no need to keep minutes or to send notices for meetings—unless you want to.  With an LLC, you set the terms governing the company via what is called an operating agreement or LLC agreement.  The operating agreement can be used to waive most of the LLC Act provisions of your state (there are some exceptions).

Why You Should Use an LLC — More Flexibility

Another key reason to use an LLC when you can is because it provides the most flexibility to a business owner looking to manage his own business.  In corporations, the more you as a shareholder are protected from liability, typically the less control you have over the company.  Shareholders of a corporation are typically only shielded from liability beyond their investment if they are removed from the day-to-day operations of the entity.  Partnerships are similar—if the general partners of a partnership actively participate in the management of the company, they are generally individually liable for any and all liability that arises from the company.

Members of an LLC on the other hand do not have to choose between limited liability and participation in the management of the company.  Members of an LLC can take an active management role and retain their limited liability protection, and LLC investors have broad discretion about how to structure the LLC management.  Unlike partnerships, an LLC can have a single member that manages the property, and none of the members of an LLC are personally liable for the liabilities of the LLC.

Why You Should Use an LLC — Maximum Tax Benefits

A third reason to use an LLC if you want a simple company structure is the tax benefit that comes with an LLC.  Corporations have less tax flexibility, and are usually subject to double taxation it the corporation wants the benefits of corporate status, like special classes of stock.  A corporation in this circumstance is taxed on its own and then its shareholders pay taxes on dividends.

LLCs on the other hand are treated as a partnership, or pass-through entity (i.e. non-taxed entity), which avoids taxation at the entity level and passes the LLC’s profits and losses through to the members of the LLC.  Members are taxed based on their Adjusted Gross Income, and are able to deduct the business’ operating losses on their personal income tax return.

Are There Any Disadvantages to Using an LLC?

There are not many disadvantages to using an LLC.  One of the only real disadvantages to using an LLC over a corporation involves the ability to exit and/or sell your business shares.  While shareholders of a corporation may freely transfer their shares to third parties and demand fair value for their shares, LLC members generally cannot simply remove themselves from the LLC and demand payment for their ownership interest or assign their ownership interest without the consent of all the members or the manager.  This is typically an issue for larger investor groups.

How to Form an LLC

The LLC is one of the easiest entities to form.  LLCs are formed by simply filing Articles of Organization with the Secretary of State. Certain basic business details must be included in the filing, such as the:

• Name of the LLC
• Address of the LLC
• Name and address of an agent for service of process in the state
• Whether the LLC is member or manager managed
• Period of its duration

While not required to form an LLC, it is best practice to also obtain an EIN for your LLC with the IRS, and to draft an operating agreement.  Both an EIN and an operating agreement are needed to open a business bank account, and it is good to have them in case your business encounters liability or member/investor growth, as they are proof of corporate formalities and the operating agreement provides guidance on how the LLC should be managed.

How to Make Your LLC “Bulletproof”

Once you have formed your LLC, you must be sure to set up and maintain “corporate formalities” of the business, to ensure that only your business, and not you personally, are responsible for the debts or liabilities of the business.  This means:

• Good bookkeeping: keep track of business income, expenses, etc. in a separate Excel spreadsheet or pay a bookkeeper to do it
• Separate business bank account: use your LLC’s EIN number and operating agreement to set up a bank account in the LLC’s name
• Commercial insurance: Make sure you have a commercial umbrella policy, separate from your personal umbrella

The goal is to keep the operation of your business separate from your personal finances.  Entrepreneurship and business ownership is an exciting endeavor.  Make sure you are starting off on the right track by talking to an attorney about forming your business.  Edwards Law is here to help.