Forming a Limited Liability Company ("LLC")-What is an LLC?
Overview
A limited liability company ("LLC") is a flexible type of business entity in which the owners can generally limit their risk to the investment that they make, and can avoid the double taxation of C-corporations. As simple as this may sound, LLCs are a fairly modern invention that are a creature of state law so the requirements and limitations on them can vary, and thus the advice of qualified accounting and legal counsel should be applied in their creation.
Historically, corporations evolved as a way for people to create a separate legal entity. That entity had its own liability (generally preventing the owner from being sued personally for the company's actions), and it had its own income (meaning the corporation paid taxes on what it made before those profits were distributed as profits through dividends to the owners). While there are more modern variations on this theme, generally a corporation has been at its core a way to formally create a separate entity.
Also from history comes the partnership, where two or more people come together for one business purpose. Because it was looked at as more of a coming together and less of a separate entity, generally partners were liable individually for the acts of their partnerships, but the money it made passed through to the partners' individual tax returns-thus avoiding having that same money taxed twice.
Each type of company has had its strengths and weaknesses, but over time investors increasingly demanded both limited liability and avoiding double taxation. Types of new corporations and partnerships evolved to fill this gap, but both retained some of the procedures and inflexibility of their original types. Slowly, however, in Latin America and in Germany a new creature was being created. Instead of relying on the slow evolution and modernization of case law to adopt old kinds of businesses, the acts of the legislatures were allowing the creation of companies with limited liability, great flexibility in structure, and pass-through taxation. The lawmakers got what they wanted as well, in that they created the parameters and requirements on these new companies. But it was such a well-received idea that states like Wisconsin passed laws allowing LLCs in 1977 and slowly all of the U.S. states followed suit.
There are still many reasons to consider partnerships and corporations when looking to create a company, but for many entrepreneurs and businesspeople the appeal of forming an LLC-and the advantages they can provide-fit what they are trying to do more than the others. There are many issues to consider for the formation of a limited liability company, some described below.
Formation of a Limited Liability Company & Management Types
Because LLCs are creations of state law, naturally they are formed by making a legal filing with the state in which you want to create the company. For small and medium-sized businesses it may make the most sense to create the LLC in the state where you are located and where the business will be run. This is more convenient, all the parties involved with the company are likely there, you are familiar with your state's government and laws. Larger companies, though, may want to look to create their LLC in Delaware or New York, where there is a large amount of case law making the legal risks of their business more predictable. Still other companies may wish to create their LLC in states with greater financial privacy, or even offshore. Wherever you decide to create your LLC it is good to be familiar with your state's particular requirements on LLCs to make certain that they match your needs.
While corporations have very formalized procedures, filings, shareholder materials, disclosures and the like, LLCs are more flexible, and the creation documents for an LLC can be very basic or very detailed. Also, unlike partnerships and S Corporations, owners of LLCs are not limited to individuals-other corporations, partnerships and entities can generally be owners of an LLC. Note, however, that some states may ban particular types of companies to own others (such as banks and insurances companies) as a way of preventing monopolies, so it is important to know the law of the state in which you are forming your LLC.
The formation of a Limited Liability Company is done by filing Articles of Organization with the state. These filing typically include the business' name, the nature of its business (which is generally kept broad), information about its registered agent (to whom legal documents are sent), as well as the names of managers and members if known. Finally, in forming your limited liability company you have to consider how long you want it to exist. Many states require that an LLC's initial documents state its duration at the very beginning.
Regarding an LLC's management, owners are called "members", rather than owners or shareholders. LLCs can be managed by a hired employee or they can be managed by a managing member. Members can own differing percentages of the company, and can negotiate and agree amongst themselves as to how decisions are made and how profits are to be split. Typically this is done at the creation of the company in an Operating Agreement. Normally these agreements establish the percentages of ownership, shares of profits or losses, rights and responsibilities of members, and what happens if a member can no longer participate. Many states do not require Operating Agreements, but creating one at the time of formation of your LLC can help you to think through important issues, and possibly avoid costly litigation in the future over what representations were made between the owners at the beginning.
Liability, Taxes and Other Pros and Cons
The primary point about a limited liability company is contained right in the name-it has limited liability for its members. This means that the people who invest in the company generally limit their financial risk to the amount they invested. If the LLC takes actions of its own, the individual owners are not typically liable-as owners may be in a general partnership or as sole proprietors. While this is a fairly simple concept, it is the engine behind the creation of many LLCs, and it is a great benefit to anyone considering forming a company. Regarding Taxes, LLCs have pass through income. That means that while the state recognizes it as a separate entity, its income is taxed at the individual member's level and not taxed at the company level as is done for a C Corporation. Any profits the members decide to take instead pass through the company to the individual members in the percentages they agreed to at its formation. The income is taxed only once-on each member's tax filing, normally on a separate attachment to it. With these features, LLCs take on the greatest strength of traditional corporations and the greatest strength of general partnerships. Thus, the formation of a limited liability is appealing for a very broad category of businesspeople and entrepreneurs.
As mentioned above, LLCs also have the advantage of not being burdened with as many document and procedural requirements as corporations (such as having a board of directors or annual meetings of shareholders), and interests in an LLC are more freely assignable (transferred or sold) than stock. However, there are also disadvantages of which one should be aware. Many states charge LLCs a franchise fee or other tax for the right to operate. Further, LLCs are a relatively new creation and may not benefit from the same, long-standing familiarity c-corporations have n the public's understanding. All of these pros and cons must be considered by the person considering forming a potential business.
Duration & Dissolution
As stated above, while the law, and even society, looks on most corporations as a separate entity with no pre-determined end, typically an LLC's lifespan is limited-either deliberately or by triggering events. The formation documents of an LLC in many states must declare its duration, either using a time period or triggering event. Businesspeople often create LLCs to perform a particular task whereupon achieving that the entity will dissolve. Other examples of triggering events are if one of the members wants to leave the company, or the company goes bankrupt or a member dies. Further, members may want to expel another member, or a court may order the company to dissolve. In many states, all of these acts can dissolve the company, and in others their effect can depend on the language in the company documents. This is yet another reason why the company's purpose must be well considered from the start, and the papers filed in the proper way.
Conclusion-the Formation of a Limited Liability Company
An LLC is a relatively new type of business entity that has all of the pros and all of the cons that that fact implies. It has limited liability, pass through taxation, and flexibility in its structure-taking the best of all of the traditional sorts of companies. On the other hand, the creator of an LLC must think through many issues about their company before deciding on an LLC, including the management structure they will need, the purpose and duration of the company, and how they want others to view it. When the decision is made to form an LLC they then have to look at where to form it, who will manage it, how they will get financing, and which of the members will be responsible for what. For the right type of business, an LLC might be just the thing. For others, the formality and respect of a corporation might need to be looked at, or the basic structure and procedures of a partnership might be best for them. Overall, forming a limited liability company has become the preferred choice for many businesspeople and entrepreneurs for its ease of use.
If you've chosen a limited liability company for your business, then Elite Incorporation is ready to form it for you and bring your business vision to reality.