The Limited Liability Company or LLC has become a popular form of business organization. You can limit your liability as a sole proprietor or a partnership by establishing your company as a limited liability company (LLC). LLCs limit your liability to the amount of capital you contributed to the firm much like a corporation. Like a partnership, they allow pass-through taxation and management flexibility. Every state in the United States and the District of Columbia allows the formation of limited liability companies.
A limited liability company may be called a limited liability corporation. That is incorrect terminology. The correct terminology is “company,” not “corporation.”
Organization of the Limited Liability Company
Limited liability companies are well-suited to a small business with a single owner. Owners are called members though they are similar to shareholders. An LLC can have one member – the owner of a sole proprietorship. An LLC can also have two or more members as in a partnership. These members can only lose the amount of capital they invested in the company. That is the beauty of limited liability.
The membership interest is similar to shares of stock. Members have control over the LLC in direct proportion to the number of shares or units of membership they own. The management of an LLC is regulated by state laws and may vary from state to state.
Setting up an LLC is a little more difficult than setting up a sole proprietorship but not as difficult as setting up a corporation. You have to file Articles of Organization with the Secretary of State of the state in which you choose to exist. You also should have an Operating Agreement though it is not required and does not have to be filed. The Operating Agreement specifies the rights of the members and the management structure of the LLC.
Advantages of a Limited Liability Company
- Less Paperwork and Recordkeeping – Limited liability companies require much less recordkeeping than corporations. You do not have to have annual meetings, for example. An LLC also does not have to have a board of directors or officers.
- Flexible Tax Treatment – An LLC is much more flexible from a tax standpoint than other forms of business organization. An LLC can elect to be taxed as a sole proprietorship, partnership, C corporation, or S corporation.
- Limited Liability – The beauty of an LLC is limited liability first and foremost. The members of an LLC can only lose the amount of capital they invested in the firm. They cannot lose their personal assets.
- Pass-through Taxation – There is no double taxation of earnings unless the LLC decides to be taxed as a C corporation. Double taxation means that earnings are taxed at the corporate level. Then, they are taxed again at the shareholder level. If an LLC elects another form of business organization, it can avoid double taxation and earnings will be taxed only at the personal level.
Disadvantages of a Limited Liability Company
- Difficulty in Raising Capital – Because the LLC is a relatively new type of business organization and not everyone understands it, it is sometimes hard for an LLC to raise money. Some banks require the members, or one member, to personally guarantee a business loan or the bank will not make the loan. This defeats the purpose of having an LLC.
- Unfamiliar Management Structure – Members of an LLC may be called shareholders, members, or other titles. The management structure of an LLC may be unfamiliar to creditors and others in the business world. This problem makes it difficult for others in the business to determine who has managerial authority and responsibility for the LLC.
A limited liability company is an option that small business owners should look at when deciding on their business structure. The small business owner should consider all the taxation, accounting, and legal ramifications before making a decision.