[This article was written by Aaron Franklin.]
The limited liability company (LLC) is extremely popular in today’s American business landscape, with thousands of new LLCs being formed each day. Clearly, the LLC is the right choice for many entrepreneurs, but it can sometimes be tough to determine if your business is ready to form an LLC, or if the LLC is a good fit for your company to begin with.
In this article, I’ll outline the seven questions you need to ask yourself to determine if you should form an LLC. While this list obviously isn’t entirely comprehensive for all industries and business types, these seven questions should help the vast majority of entrepreneurs determine whether they should form LLCs. Let’s find out if the LLC is the right business structure for you!
- Do you need personal asset protection?
If you’re currently operating a sole proprietorship or general partnership, the biggest advantage of forming an LLC is the limited liability protection it provides. Thanks to the LLC’s business structure, a lawsuit against your business will not permit your creditors to pursue your personal assets. This means that your house, car, personal bank accounts, and other assets will be protected.
For most businesses, it’s vital to have this personal asset protection, because it can mean the difference between a minor setback and a catastrophic financial disaster. If the products or services you sell to your customers carry any potential liability, forming an LLC is probably an excellent plan. However, if you run a freelance writing business out of your own home, for example, you may be able to get by as a sole proprietorship.
- Can you take advantage of flexible taxation?
One popular aspect of the LLC is how it presents its owners with options regarding taxation. With a sole proprietorship or general partnership, the only tax structure available to you is the pass-through model. With this form of taxation, the profits or losses generated by your company “pass through” the actual business entity to the owners. There is no tax paid by the business itself. Instead, the owners pay tax on this money through their own personal returns.
With an LLC, the default method is this same pass-through model. However, an LLC may also elect to be taxed like a C corporation or an S corporation. C corps are subject to “double taxation,” which means the entity itself pays corporate taxes, and the shareholders pay taxes again on that same money when it’s distributed.
Even still, this form of taxation can save you money if your owners are high-income individuals who occupy high tax brackets. The other option is S corp taxation, which is similar to the default pass-through model, except for the fact that its owners do not have to pay self-employment taxes, which LLC owners are subject to.
- Can your business benefit from enhanced professionalism?
One issue with sole proprietorships and general partnerships is that your business name is just your own personal name. For example, if your name is Susan Jones, your business name is also “Susan Jones.” On the other hand, an LLC has an official business name, so Susan would be able to register a business name other than “Susan Jones.”
This enhances the perceived professionalism of your business because most customers are more comfortable writing checks and paying invoices to a business, rather than an individual. Furthermore, every LLC has either the words “limited liability company” or the initials “LLC” in its name, which adds another layer of credibility.
- Do you need an exclusive business name?
Even if your sole proprietorship or general partnership acquires a doing business as (DBA) name to register an assumed business name, you will not have the exclusive rights to that name. This means that if the owners of an LLC or corporation decide that they like your DBA name, they are not only allowed to use it for themselves, but they can also prevent you from ever using it again. With an LLC, you receive the exclusive rights to your business name, eliminating this concern entirely.
- Do you have employees?
While sole proprietorships and general partnerships are allowed to hire employees, there’s some risk involved due to the business’ lack of limited liability protection. For example, if an employee slips and falls while working, they could sue you, and as such they could have access to your personal assets. Of course, this isn’t an issue for LLCs because they have personal asset protection, as we’ve already discussed.
- How much business does your company do?
If your company handles a very small volume of business, it may not be worth the hassle or cost of forming an LLC. Your sole proprietorship or general partnership might be able to get by without LLC status if you only complete a few hundred dollars’ worth of transactions per year. In addition, there are expenses associated with forming and maintaining an LLC, so if your business isn’t very active, you might not want to bother.
- Are you trying to attract investors?
So far, I’ve focused on the differences between LLCs and sole proprietorships or general partnerships. However, if you’re seeking outside investments, you should probably form a corporation instead of an LLC. This is due to the fact that LLCs cannot issue stock, which is by far the most valued asset for a typical investor.
In addition, LLCs aren’t seen as being particularly inviting to venture capitalists, so that’s another advantage in this area for corporations. LLCs can bring in additional sources of funding by adding new owners to the company, but this involves a significant transfer of power that you might not be comfortable with.
There are quite a few benefits to forming an LLC, but it still isn’t the perfect solution for every single business out there. If you ask yourself the seven questions I outlined in this article, you should be able to figure out whether the LLC is the right business entity for your company.
The only times I think it’s acceptable or advisable to simply operate as a sole proprietorship or general partnership are if your company only performs a small handful of low-profit transactions each year, or if your products and services don’t present any liability concerns. However, it’s important to keep in mind that LLCs aren’t a great option for attracting investors. So, if this is a priority to you, the corporation is probably a better option.
I hope this article helped you decide whether the LLC is a good fit for your business! If you’re still not sure if you should form an LLC or not, I would advise contacting a business attorney. An experienced lawyer can help you determine which entity type is the best choice for you.
Frustrated by all the options and aggressive online sales tactics, Aaron Franklin created BestLLCServices.com to cut the clutter and bring clarity to entrepreneurs starting an LLC. His focus is on reviewing and comparing the top LLC formation services while also crafting free resources that help you start a business. Aaron and his team sincerely believe finding the right service and free information should be a simple process so entrepreneurs can get started with minimal friction.