Top 7 Reasons Startups & Small Businesses Form an LLC

The limited liability company (LLC) has only been recognized in all 50 states since 1996, but today it is one of the most popular business formation structures in the American business landscape. Clearly, there’s something about the LLC that entrepreneurs really appreciate.

Depending on the exact nature of your business, your reasons for forming (or not forming) an LLC could vary. However, there are some general benefits of the LLC that contribute significantly to its popularity. In this article, we’ll discuss the seven main reasons why startups and small businesses form an LLC.

Along the way, we hope to help you figure out whether the LLC is the right structure for your business.

1. Protect Your Personal Assets

One of the most popular reasons to form an LLC rather than conducting business as a sole proprietor or general partnership is that this business entity provides personal asset protection. Unless you use your LLC to commit fraud, the LLC’s business structure limits your personal liability in case your company is sued.

With a sole proprietorship, you would be required to personally cover the costs of a business lawsuit, whereas with an LLC, your personal assets like your car, house, and personal bank accounts are not accessible to your company’s debtors. An LLC owner is only liable for his or her own contributions to the LLC.

2. Flexible Taxation

An LLC may also elect its own taxation structure, which allows you to choose the tax strategy that best suits your business. As an LLC owner, you have three main options for taxation.

You can take the default strategy of pass-through taxation, which means your business entity itself does not pay taxes. Instead, the profits or losses of your company “pass through” the LLC to its owners, who report those funds on their own personal returns.

You can also elect to be taxed like a C corporation, which subjects your profits to double taxation. This means that the company’s profits are taxed first on the corporate level, and then that same money is taxed again when it’s distributed to your owners.

The other option is for S corporation taxation, which is quite similar to the pass-through method, except for the fact that an S corp’s owners are considered to be employees, so in this case you’re not subject to paying self-employment tax like you are with the default model.

The fact that you’re given a choice at all is one of the biggest advantages the LLC has over other business structures.

3. Easy to Register/Form

The LLC certainly does take more effort to form than a sole proprietorship or general partnership, because there is no actual formation process for these entities — they are simply formed by default the moment you start conducting business. However, the LLC formation process is still significantly easier and less time-consuming than that of a corporation.

All you need to do to get your new LLC up and running is draft and file a document typically known as the articles of organization. While the exact requirements for this document do vary somewhat from state to state, in general you’ll just need to provide some basic information like the name and address of your business, the identity and location of your registered agent, and the names of your LLC’s owners and organizer.

Plus, if you need help creating your LLC or just want to save the time, consider hiring an attorney or LLC formation service.

4. Enhanced Credibility and Name Exclusivity

When you operate a sole proprietorship or general partnership, the legal name of the business is simply your personal name.

Even if you acquire a doing business as (DBA) name as one of these informal business entities, you will not receive exclusive rights to that name — if an LLC or corporation decides they like your DBA name, they are legally allowed to start using it for themselves.

However, with an LLC, your business has a distinct legal name, and you retain exclusivity regarding the use of that name. This has the added benefit of enhancing the credibility of your business. After all, people are probably more comfortable writing a check or paying an invoice to a business name, rather than to you as an individual.

5. Raise Capital by Bringing in New Member/Owners

While the LLC can’t issue stock like a corporation can, LLCs still have ways to bring in additional outside capital. Namely, an LLC can bring in new members to join the company’s ownership group, which is an effective way of acquiring an influx of new money into your business.

Keep in mind that corporations have a much easier time raising capital than LLCs do, but if you’re willing to give up some of your responsibilities to a co-owner, the LLC has some options of its own in this regard.

6. Easy to Make Structural Changes

The LLC as a business structure is quite flexible. It’s pretty simple to amend your articles of organization, change your ownership structure, swap out your managerial roles, etc. Corporations are a much more rigid structure, as they need to strictly maintain separation between the roles of their board of directors, appointed officers, and shareholders.

7. Flexibility When Allocating Profits and Losses

When you operate a corporation, you need to follow stringent rules and regulations about how your profits and losses should be distributed amongst your shareholders. With a corporation, distributions are all about how much stock each person holds, which entirely dictates how much money they’ll receive.

As for an LLC, this is not the case. If it uses the default pass-through taxation method, an LLC may split up its profits any way the owners want to. If your owners have an uneven split regarding the management procedures of the business, you can reflect that uneven split in the way you allocate your finances.

Or, for another example, you can split up profits based on how much of an initial contribution each member made to the LLC. In other words, you can split up the money in any way, and you don’t even need to have a particularly good reason for choosing the distribution methods you use.

Is an LLC the Right Entity Type for Your Business?

Overall, it’s tough to make blanket statements about whether an LLC is the “best” business structure for your specific business, as every company has its own unique needs. In general though, the LLC is the preferable entity type unless one of the following two conditions applies to your business:

●  You want to attract investors by issuing stock or pursuing venture capital investments

●  You have ambitious expansion plans that involve international operations

In these situations, the corporation is likely the better fit for your business. We already discussed how the LLC is limited in its pursuit of investments, and it is also not recognized in foreign countries, whereas the corporation is.

As long as these conditions don’t apply to you, the LLC is probably a great fit for your business. Hopefully, this brief guide helped you understand the main reasons why startups and small businesses appreciate the LLC as a business entity.