So, you have a great business idea and are ready to breathe life into it. Besides thinking of a business name, picking the right business structure is one of the most important decisions you’ll ever make. Activities and operations, including raising funds and paying taxes, greatly depend on the business model you choose.
Forming a limited liability company or LLC is one of the most popular choices for many reasons, including liability protection, adaptable management structure, and tax flexibility. However, there are downsides to consider when choosing this option.
Weighing the pros and cons of an LLC will help you decide whether this entity aligns with your business goals and circumstances. Allow this post to name some of these.
LLC, in a nutshell
According to the US Chamber of Commerce, the country has seen a record-breaking 5.5 million business applications in 2023. Small businesses comprise over 99% of enterprises, including limited liability companies.
An LLC is a business entity that combines the aspects of sole proprietorships, partnerships, and corporations—with few exceptions.
Generally, LLCs offer owners personal liability protection similar to a corporation. In the eyes of the law, an owner or member can’t be held responsible for debts owed by the business.
One or more persons can own an LLC. Tax-wise, it offers passing through profits and losses to its members’ personal tax returns like a partnership. Single-member LLCs, which aren’t taxed as business entities by the Internal Revenue Service (IRS), are taxed similarly as sole proprietorships. As such, the owner or member must report losses or income in their personal tax declarations.
At the same time, LLCs with two or more owners are generally treated as partnerships unless they move to be treated as corporations. The same state-specific rules apply for single-member and multi-owned LLCs, however.
Do I need to separate my finances personal finances when forming an LLC?
Since owners are legally considered as separate entities from their business, it’s best to open a business bank account when forming a limited liability company.
Besides American citizens, foreigners and non-residents can also file for LLC formation. Ensure you meet the requirements and eligibility to open a business entity and a business bank account for non-US residents.
The pros of owning an LLC
Although the laws that apply to limited liability companies vary slightly from state to state, forming an LLC for your small business comes with major perks that benefit your operations and finances. Take a look at some of them below.
- Limited personal liability
If you’re an entrepreneur concerned about shielding your assets in case your business doesn’t perform well, you have nothing to worry about. An LLC ownership recognition means you can’t be held personally responsible for business debts and claims. In other words, your properties, personal bank accounts, investments, and real estate can’t be seized to settle your venture’s financial obligations.
- Tax flexibility
As mentioned, LLCs can file and be taxed as sole proprietorships, partnerships, and S or C corporations. You can choose the option with the lowest overall tax payment and maximum write-offs. The good news is that LLC owners can use business losses to offset income from other personal income sources.
- Fewer formalities and regulations
Forming an LLC subjects you and your co-owners to far fewer regulations and paperwork than incorporating your business. Maintenance and compliance rules are less laborious compared to the requirements corporations have to meet. For instance, corporations must conduct board meetings and observe proper quorum and voting rules before making certain decisions. These are optional in LLCs, giving you enough time to focus on your growing company.
- Credibility
Creating a formal business entity like an LLC can boost your credibility with customers, partners, and lenders. It shows you run a professional business recognized by the state. This proves helpful when seeking to expand and deal with business allies seeking assurance and stability.
Limited liability companies provide their members invaluable protection, flexibility, and other benefits. Additionally, it cuts the red tape and common barriers to business growth. For most, these reasons are enough to compel them to consider this model.
Cons of forming an LLC
On the flip side, establishing a limited liability company also comes with certain drawbacks that a budding entrepreneur must be aware of. Consider the following points:
- Self-employment taxes
The self-employment tax applicable to sole proprietorships, partnerships, and independent contractors doing business is 15.3 percent. It applies to individuals earning up to USD$ 168,600 starting this year. Business owners operating as LLCs must cover this in full because they’re both considered employees and employers.
Self-employment tax is paid on top of personal income tax. These payments could take a significant bite, so be sure to consider them when planning your budget.
- Limited lifespan
Unlike corporations, which can exist for a lifetime, LLCs’ lifespans are typically fixed based on the articles of organization. Bankruptcy, a member’s death, or departure from the company can also cause dissolution—but only after the liabilities have all been settled. Regardless, this can cause business disruptions. You may want to plan an exit strategy if you or your partners decide to leave the business.
- Difficulties raising funds
One of the major differences between a corporation and an LLC is that the latter can’t sell stock shares through initial public offering (IPO). This can be challenging if you’re hoping to attract big investors.
That said, your options to ramp up capital may be limited to taking out loans or bringing minority stakeholders. While minority stakeholders have a voice in the company, their rights may be restricted according to the operating agreement, so it isn’t exactly an attractive option to some investors. Regardless, limitations in boosting capital restricts an LLC’s growth.
- Varied state requirements
The regulations around forming and operating this business structure vary on the state you wish to file in. Staying compliant with the state and federal LLC rules can be complicated for some, especially when running a business in multiple states. Minding the differences is key.
While your home state is often the best option for filing an LLC, you can do it in other territories as a non-resident. You must hire a registered office or agent for your peace of mind if taking this route. For reference, Wyoming and Delaware are often cited as two of the best states to form an LLC—primarily because of lower tax rates and more stringent business privacy laws.
While these drawbacks may not necessarily outweigh the advantages discussed above, they require careful consideration before choosing this business structure.
The bottom line
Forming a limited liability company offers significant perks, especially for business owners seeking protection and flexibility. Choosing such an adaptable model can save owners from significant issues down the road. However, it doesn’t necessarily make your business instantly better. You still need to run your enterprise right, as with other ventures.
It pays to look hard at what you stand to lose or gain with an LLC before jumping in. Ensure it aligns with what you want to do and how you envision the future of your business. At the end of the day, this structure may offer attractive benefits, but it isn’t the right choice for every profitable enterprise.
