If you’re running a business, you may worry about how to take care of it long term. When looking for lasting success, one has to prepare for the unexpected: market downturns, refunds, sometimes lawsuits.
After spending years growing the company, the last thing you want is to lose everything you own because of a costly accident. No matter how well you prepare for the future, something negative will affect your business. LLCs offer legal protection to minimize those damages.
Due to their limitations, LLCs aren’t the right choice for everyone. It sounds smart to create this structure for a small business, but you may change to an S or C type corporation later when scaling the company.
The downsides cost more money than what you pay for an LLC. Before you do, make sure to study the pros and cons.
Who Needs An LLC?
As its name says, Limited Liability companies protect your personal liabilities. Although it maintains some benefits of the sole proprietorship, it separates you from the business, so that any debt generated cannot affect your house, car, savings account, and possessions.
A lawsuit may cost you the business, but you can still have your personal assets to rebuild it. On a sole proprietorship (the default business structure that requires no registration), it would cost you everything.
But LLC has limitations in order to provide that protection. Here are the features:
CON: The LLC Cost
Getting an LLC costs anywhere from $100 to $500 for the registration. Although some states may keep it for free, you may need to pay up to $800 per year to maintain this business structure.
It may not be a lot of money for a business, but many can see it as an unnecessary cost. Unless you’re selling a dangerous product, customers will rarely sue these companies. The owner may offer compensation to avoid further problems.
When you’re just starting the company, have few clients, and aren’t making a decent profit, LLCs are unnecessary. After you grow enough, it won’t hurt to pay a few hundred per year to protect your assets.
You don’t need to file an LLC in the state where you live, not even in the US. You can get it anywhere, just as you can choose to sell whatever marketplace you want.
If a state allows registering LLCs for $100, you can choose that state and save a few hundred. You can get a US LLC from anywhere in the world.
When reporting business revenue, the owner can do it on a personal tax return and avoid double taxation. Record-keeping is more flexible. You neither need to arrange annual meetings like other corporation types do.
CON: Personal coverage only
As a confident entrepreneur, one may want to reinvest as much as possible into the business to grow faster. In the event of a loss, an LLC can’t protect your business, which means losing years of work and money invested.
If the company is your main concern, expand your LLC with General Liability Insurance. It protects all your business assets up to a certain amount, which will help small business owners to recover from those losses.
PRO: Tax Flexibility
Limited Liability Companies can follow whatever tax structure is the most convenient for you. It will often be the one you had in the sole proprietorship: The IRS doesn’t consider the business structure and taxes you as an individual. You only pay based on the revenue you report at the end of the year.
Because the IRS taxes individuals, you can distribute your business profits before taxing it. On a multi-member LLC, the team agrees what distribution is the most tax-friendly and beneficial for the business. You can use it as an incentive to pay other workers based on how much they contribute to the company.
CON: LLC Organization
As a different entity, it should be easy to differentiate the business from personal accounts. The person who sues can still hold you personally liable if you don’t operate the way LLCs do, even when everything looks right legally. It’s not infallible protection.
Although this structure has its pros, you still need to pay for self-employment and excise taxes.
PRO: LLC Formation Services
Given the interest in this business structure, many agencies offer help to make your LLC official. They take care of the paperwork, such as the operating agreement and tax conditions.
LLC services can use their name to back up the business contact information, keeping your credentials private. For different reasons, entrepreneurs benefit from keeping their personal data invisible to the public.
CON: Investors won’t invest in LLCs
Since these companies act as “pass-through entities,” you can’t collect venture capital funds from investors. When your goal is to get funding, it’s going to be more expensive to cancel your LLC structure and create a C Corporation. Although double-taxation is possible in this last type, you can avoid it.
When the IRS exempts companies from business taxes, you can’t receive active trade or financing. Fundraising is possible but far more complicated than with S or C corps.
Think ahead, because it will cost less time and money to pick the right type now than converting later.
What We’ve Learned
Although useful, LLCs aren’t necessarily your best option when protecting a business. Whether you choose this structure, a C, or S-type corporation, you’ll get more benefits than if you stay on the sole proprietorship.
Just as you think ahead to prevent losses, think of how you want to grow your business. Depending on your vision, you will choose one structure or another. You can always switch from an LLC to another model later, but it will involve more paperwork and expenses.
Before you think of legal matters, ask yourself what protection you need for the risk your business encounters. If you go ahead, you may want to protect business assets as well with general liability insurance.
Legal protection will allow you to keep doing business despite the uncertainty. But beware when getting too many complaints. Keep improving product quality and security so that you don’t lose your clients and credibility.