Choosing a legal structure for your business is one of the most significant decisions you can make as a fledgeling entrepreneur. There are several options that could be suitable for your company, but in order to opt for the right one, you need to understand the pros and cons of each.
One such possibility is a limited liability company, or an LLC. Generally, they are created for the purpose of protecting tangible assets, such as real estate or vehicles, but they can also define your ownership structure (an LLC can have a single owner or multiple owners, for instance).
Therefore, in order to determine whether it's the right fit for you and your organisation, we've compiled a list of the main pros and cons of an LLC.
Pros of an LLC
Despite many thinking otherwise, LLCs are not defined by their size, and can be big or small. Indeed, their flexible nature is what makes them popular with many entrepreneurs, while other prime benefits of setting up an LLC include:
This is the chief benefit of this structure and is precisely what the term "limited liability" refers to; as an LLC, you are safeguarded from personal liability should things go wrong.
This means that creditors, or anyone filing a lawsuit against the company, will not be able to target your personal finances or assets if you owe money on the business. In practical terms, this translates to protection from unpaid business debts that are not personally guaranteed, disputes with vendors, and damages caused by your company.
Ease of Use
In most countries, an LLC is the simplest and least expensive business structure you can set up. In places where online registration is available, the entire process can be completed in just a few days – if not quicker. Essentially, all you need to do is file articles of organisation and ensure that you complete any other associated formalities, such as choosing a registered agent and establishing an employer identification number.
No Restrictions on Partners or Members
There are no restrictions regarding the number of partners or members an LLC can have. LLCs can even be owned by other LLCs.
Flexible Tax Structure
LLCs usually have the flexibility of choosing their own tax structure, with the "pass-through" approach often preferred by LLCs (and corporations). Here, the profits earned by the company go to its members; they then absorb this tax liability and report it on their tax returns.
No Salary Restrictions for Partners or Members
In an LLC, payments to a member or partner are independent of their ownership share. Compensation can be delivered as guaranteed payments, which would be seen as earned income and fetch all associated tax benefits.
Minimal Compliance Issues
An LLC is not required to have annual meetings or even constitute a board of directors, meaning the need for paperwork and record-keeping is kept to a minimum.
Following the death of an owner or member, the company can continue as an LLC provided it is a unanimous decision by all other members.
Cons of an LLC
Of course, as with all business ventures, there are some disadvantages of turning your business into an LLC, too. For instance:
Limited Liability Protection Does Not Offer Blanket Protection
Unfortunately, limited liability means just that: it is limited. An LLC only protects you if you are not personally responsible for injuring someone, or misusing company equipment or funds. If you fail to keep your personal interests separated from your business interests, then LLC cannot offer you protection in these instances.
Excise and Self-Employment Taxes
As an LLC owner, you will need to pay self-employment taxes on your salaries, as well as on any profits. Of course, there are ways of avoiding profit taxes, but taxes on salary are unavoidable.
It is Relatively Unstructured
As, in many jurisdictions, there are no strict regulations in place concerning how you conduct business as an LLC, this can spell trouble in the long term. It can also prove a deterrent when seeking external funding as investors may be reluctant to put their money into an organisation without a regulated corporate structure.
Immediate Profit Distribution
While corporations can hang on to their profits until they figure out how to channel them, LLCs must immediately disburse their earnings to members.
Added Tax Burden
Quite often, LLCs may be subject to additional taxes depending on the relevant laws of their registered jurisdiction.
In some jurisdictions, an LLC must be dissolved if one of its members goes bankrupt, dies, or leaves the company. If this happens, there is a double whammy, too: the rest of the members must fulfil any pending financial or legal obligations before terminating the business. If they want to continue trading, they will have to start a new LLC from scratch.
Since there is a lack of well-defined roles in the management hierarchy of an LLC, it can cause confusion regarding the daily running of the company. This lack of decision-making authority can also prove off-putting to potential investors.
It is much easier for a corporation to go public than for an LLC as the latter lacks a stable structure and will not be able to issue shares.
Fewer Employee Benefits
As an LLC, your employees might have to treat benefits such as medical insurance and medical reimbursement plans as taxable income. This can be a deal-breaker when seeking to recruit new employees.
There is no doubt that an LLC offers a host of protections and flexibility; it is a good option for many small business owners, in particular. However, ensure that you evaluate all the relevant advantages and disadvantages above and how they will impact your business plans in the short, medium and long term.
Before you make your final decision, conduct thorough research into the alternatives as well, such as a sole proprietorship or incorporation. Only make this decision after a great deal of reflection and, if necessary, consultation, and remember that it will have long-reaching effects on the organisation and you as an individual.
What other key pros and cons should be considered? Let us know your thoughts and experiences in the comment section below.