Why should anyone form an LLC? Most people have heard of the LLC, but somewhat less than 100% of those people could tell you that it stands for limited liability company, and an even smaller percentage could tell you why to incorporate, let alone why to incorporate as an LLC. Fortunately for anyone who’s stumbled into choosing an LLC as the corporate form for their business, it’s a pretty good choice for a lot of people. Here’s why:
Benefits of Incorporating Generally
The limited liability company is just one type of corporate form that a business can take. You could also incorporate as an S-Corp, a C-Corp (the same thing with different tax consequences), or a limited liability partnership (among other things). But why choose any of these? There are two main reasons.
The first reason is liability. By incorporating you create a legal entity that is separate from yourself. It’s this legal entity that conducts the business, and if you incur liability as part of the business that liability is going to be pinned to the legal entity you’ve created, not to you personally. With a few exceptions that are better talked about in a separate post, that means that your personal assets will not be up for grabs if the business is sued. To ensure that this remains the case, it’s always important to follow corporate formalities and make sure the business is either adequately capitalized or insured to be able to pay debts and liabilities. Importantly, where there are multiple people in a business, incorporating means that you won’t be personally liable for the actions of one of your business partners. Before the corporation, when people operated in partnerships, each partner was not only personally liable for their own actions, but they were personally liable for the actions of their partners. Many people who don’t incorporate but have a business partner don’t realize that they’re effectively a partnership for legal purposes, and the legal exposure they have as a result. Incorporating solves that problem.
The second reason is pooling of resources and sharing of ownership. Simply put, it’s a heck of a lot easier to have a bunch of different owners with different ownership stakes and levels of control when there’s a corporate structure in place. Again, absent a corporate form of some kind two or more people working together as a business will be a partnership, with each partner entitled to an equal share of profits (regardless of how much they’ve contributed) and an equal say. Moreover, each time a partner leaves the partnership, the partnership ceases to exist, and must be reformed. By incorporating in some form, that separate entity lives indefinitely and allows owners to set up different levels of ownership and control as they see fit.
Benefits of the LLC
As I said above, the LLC is just one of a number of different options when it comes to corporate form. It’s also a pretty good one. And there’s one big reason: it’s easy. That alone makes it the right choice for a lot of businesses.
It is, of course, important to note right off the bat that the LLC gives you all the protections and benefits that you’d want from a corporate formation. It’s a distinct legal entity that provides a liability barrier between the individual and the company and it provides a good framework for dealing with multi-person ownership and control. In other words, it gives you everything that most people looking for corporate status need.
And it’s easy! And flexible! This is the big advantage that the LLC has over what one would think of as a typical corporation. Corporations have to deal with a lot of formalities imposed by statute. Those formalities vary by state, and corporations have the latitude to make many of their own rules, but there are certain things in each state that corporations just have to do every year. Whether it’s holding a shareholder meeting (or getting written consent from all shareholders not to have a meeting), or appointing directors and officers, there’s just a lot of stuff to do. That means you have to be aware of all that stuff, or pay someone else (like me!) to be aware of it. For a lot of small businesses, it’s just an added hassle with added expense that doesn’t add any value.
That’s why they created the LLC. The LLC gives you the benefits without the formalities. That’s what makes it easy. In Massachusetts, unless you’ve implemented your own requirements in your Operating Agreement, you’ve just your yearly filing with the Commonwealth. That’s it, once a year, pay a fee and fill out a form. Easy. And what’s that business about setting up your own requirements in the Operating Agreement? Well, LLC’s can be tailored to look and function essentially however you want them to. Want it to work just like a corporation? Go for it (wouldn’t make a lot of sense, but maybe you like paying lawyers to draft documents, which I can get behind). Want as few formalities as possible because the LLC is really just one person? You got it.
Of course, the LLC is not without its drawbacks. The primary one is that in situations where standardization is valued, the LLC is going to be a wildcard. For example, if you’re a start-up tech company hoping to take outside investment or get bought out, you’re going to be more attractive as a Delaware Corporation, that’s just the reality of it. The reason is that an investor wants to look at you, know you’re a Delaware Corporation, and immediately know what rules apply. If you’re an LLC, they’ve got to have their lawyers go through your Operating Agreement and state LLC statute and figure out what you are and how you work. They also probably can’t use the same documents they’ve used on 100 previous transactions. That increases transaction cost, which makes you less attractive. So in that case, probably best just to deal with the annoyances of being a corporation so you look better to investors. Thems the breaks.
But if you’re a coffee shop, a graphic designer, or just about any other type of business? Take a long look at the LLC.