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, especially 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. We have written a 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, it is likely 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 do 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.
- Pass-through taxes - An LLC’s net income will pass down directly to the individual LLC owners. The owners then report their share of profit and loss on their individual tax returns, meaning you avoid double taxation that exists with corporations.
- Credibility - An LLC is recognized by partners, suppliers, and lenders as more favorable. The business name will let customers take your business more seriously.
- Management - There are no directors or shareholders to maintain.
- Distribution - Not required to distribute profits equally according to number and types of shares held. Ownership and profit distribution percentages can be different.
- Simplicity - LLCs require less paperwork and formal meetings, roles, and record keeping procedures compared to corporations.
What are the Disadvantages of Forming an LLC?
There are also downsides to LLCs:
- Limited Growth - The owners of an LLC cannot issue shares of stock to attract investors, thus potentially making it more difficult to raise capital.
- 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 if they received a cash disbursement from the company. This may cause an undue cashflow 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.
What Are The Steps to Form a New LLC?
An LLC can be formed in 5 steps:
- Name your LLC
- Choose a registered agent service
- File Articles of Organization
- Prepare an operating agreement
- Apply for a Federal Tax ID (FEIN)
1. Name Your LLC
The name that you choose must comply with 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 or 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.
Choose a unique name that is distinct, easy to remember, easy spelling, and simple-to-pronounce. Select an LLC name that represents your service and distinguishes you against competitors.
2. Choose a Registered Agent Service
LLC’s 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, staying up-to-update on compliances with State requirements.
Requirements vary slightly in each state, but generally registered agents must:
- 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.
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, 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, we recommend using a third party commercial registered agent service. Besides providing a degree of privacy, commercial registered agents also offer the following benefits:
- Flexibility - You would 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, report due dates, and disparate laws of different states.
3. File Articles of Organization
To create an LLC, many states only 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 fairly 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.
What is a Business Address?
A commercial business address is an address that is used to designate your principal place of business. It is where your business is supposedly operating from.
A commercial business address is required for registration purposes when you apply for an LLC or a corporation. A commercial business address must be a legally valid address that is a physical address for delivering statutory government mail and legal notices. Additionally, a physical street address is required for your registered agent (PO boxes are not accepted).
The recommended address is a commercial business address.
There are benefits to having a commercial business address:
4. 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 strongly recommended as it provides a number of safeguards and adds more protective measures in case of disputes or lawsuits.
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.
5. 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 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 number immediately.
In order to apply for the EIN online, the business must be based in the United States or U.S. Territories and the person applying must have a Taxpayer Identification Number (TIN) or social security number. 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, relatively 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 less legal and corporate formalities, leading to simpler and easier maintenance. Additionally, if your business is at a high risk for failure (which all new startups fall under), then an LLC will help better protect your personal assets.
At a minimum, we recommend using an LLC over 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.
Still Have Questions About What Business Structure to Choose?
Download our Business Structure Comparison to determine what is the best business entity type for you.