Legal Structures for Your Startup: What are the Options?
To understand what makes the LLC structure so valuable, it’s helpful to compare it with some of the other options:
When you first begin generating income through your business, you’ll automatically be considered a Sole Proprietor in the eyes of the government. What you should know about Sole Proprietorships is that they do not establish a new legal entity; in other words, there is no legal differentiation between the business and the owner, and no separation between business assets/liabilities and personal assets/liabilities.
Another option to consider is the Partnership. This is very similar to a Sole Proprietorship, only it involves profit-sharing between two or more entrepreneurial partners. Again, no new legal entity is created.
An LLC does create a new legal entity. Your business is seen as distinct from its owner, which means you can maintain a clear demarcation between business assets/liabilities and personal ones. This comes with a number of built-in advantages… but more on that in a moment.
Finally, you can choose to incorporate. Corporations face much stricter regulatory requirements than these other business types, including the requirements to sell shares, hold regular shareholder meetings, and file robust annual reports. The corporate model may make sense for much larger enterprises, but for the majority of smaller companies, the LLC is more appropriate.
What are the Advantages of an LLC?
What are some of the reasons why entrepreneurs choose the LLC format?
1) Personal Liability Protections
✅ The fact that an LLC establishes a separate legal entity, allowing you to keep your personal assets safely removed from your business assets, is a huge boon.
What it means is that, if a lawsuit or a creditor targets your small business, all of your personal assets (including family assets) are off the table. This personal wealth protection provides entrepreneurs with peace of mind to invest in their companies, knowing they can manage and mitigate their own personal risk exposure.
2) Tax Flexibility
✅ Entrepreneurs also benefit from some leeway with regard to how they file their taxes.
The default position for LLC members is to declare income on their personal tax returns, without filing a separate return for the business. They are then taxed on a pass-through basis. However, as the business grows, the LLC members may elect for taxation on a corporate basis, if that’s a better fit for their tax strategy.
3) Managerial Flexibility
✅ In addition to wiggle room with how you file taxes, an LLC also offers some flexibility with regard to how you run the business day-to-day.
Depending on how you draft your Operating Agreement (more on that later), you can choose to run the show all on your own, share duties with one or more partners, or outsource to a third-party management company. Still another option is to start out running things by yourself, but create a structure through which you can bring in partners later on.
4) Regulatory Ease
✅ While there are certain steps you’ll need to complete to ensure your LLC is properly registered, the regulatory burdens are ultimately much lighter than they would be for other types of companies, especially Corporations.
Consider: You don’t have to hold annual shareholder meetings, you don’t have to file very public reports, you don’t have to keep meeting minutes, and you only have to do some very basic administrative stuff on the front end.
The bottom line? LLCs make it easier for entrepreneurs to focus on running their businesses, not handling regulatory issues.
How to Launch an LLC for Your Small Business:
Clearly, there are a number of advantages to establishing your startup as an LLC. Now the question is how.
The short answer: It kinda depends. The steps for beginning an LLC can vary from one state to the next. And you may or may not wish to enlist a professional LLC service. (For one example, consult the LegalZoom LLC cost.)
With that said, there are a few basic steps that tend to be more or less the same from one state to the next. Here’s what you should know about registering your startup company as an LLC.
1) Choose a name for your business.
Choosing a name for your company isn’t merely about branding or marketing, though both of these concerns are important for long-term business success.
The name you select also has legal implications. That’s because most states require you to register a name that isn’t already in use by another LLC. Thankfully, there are usually online directories available to help you vet the name of your choosing.
Note: When you register an LLC, you can also register DBA (or “doing business as”) names. These are essentially unofficial brand names that can operate under the umbrella of your official LLC name.
2) Select a Registered Agent.
Each and every LLC needs to designate a Registered Agent. This can be an individual or an organization, appointed to receive legal and tax correspondence on behalf of the LLC.
The question before you is, will you serve as your own Registered Agent, or hire someone? Given that a Registered Agent service is often as cheap as $50 annually, and significantly reduces the amount of paperwork you have to comb through, most LLC partners go this route. Simply make sure you have a Registered Agent with a physical address in the state where your LLC is registered. A P.O.Box won’t do!
3) File Articles of Organization.
Naturally, the first step toward any successful business is… filing paperwork! While the specifications for an LLC’s Articles of Organization are fluid from one state to the next, the requirements are usually: Business name, business purpose, names of all partners, and name and contact information for your Registered Agent.
When you file, you’ll also have to pony up for your state’s LLC filing fee. Good news: This is usually pretty cheap, as little as $20 and never more than $300.
4) Draft an Operating Agreement.
Think of the Operating Agreement as a constitution for your LLC. You aren’t legally required to have one, but putting one in place can significantly reduce your risk for infighting or disagreement later on.
The Operating Agreement should specify (among other things):
- How you will split managerial duties with your partners.
- How you will distribute profits between partners.
- How you will bring on new partners.
- How you will deal with a partner who chooses to leave the company.
5) Get your banking affairs in order.
Sooner or later, your startup will need an employer identification number, or EIN. This isn’t required to register your company, but it is required to administer payroll or to file your taxes.
Also be sure you have a separate business bank account. This should not be connected to your personal banking or checking account. To maintain the personal liability protections of your LLC, stick to this rule of thumb:
Don’t use personal assets to pay for business expenses, and don’t use business assets to pay for personal expenses.
Maintaining separate bank accounts is critical for complying with this rule.
6) Keep up with reporting requirements.
Compared to Corporations, LLCs don’t have very stringent reporting responsibilities. Most states do require you to file a basic report each year, simply reaffirming your business name and the names of your partners.
Something else to keep in mind: If you change your Registered Agent, or if your Registered Agent has a change of address, you should report that to your state right away.
An LLC Can Help You Establish Startup Success
Launching a new business can be enormously rewarding. As you dream and plan for your future, be sure you establish the right legal foundation. For most startups, that means choosing the LLC format.
An LLC will yield a number of benefits for your startup, positioning you for scalable success. These benefits include personal liability protections, tax flexibility, low regulatory requirements, and plenty of options with regard to how you operate your company.
As you consider the steps required for a successful LLC, make sure you register your name, pay your fees, appoint a Registered Agent, and get your documents in order. Then, stay up to date with reporting mandates. With any questions, seek insight from a business consultant or coach in your area.
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about content and social media marketing.