So you have decided to follow your dreams and start your own business doing what you love. You have created your business plan and now you are ready to put your plan into motion and start your own company. The next step is to consider which business structure suits your business. As you recall, this is part of the first legal consideration in starting your own business, as discussed in my previous blog, found here. A business can be structured as a sole-proprietorship, partnership, limited partnership, corporation, S-corporation, or a limited liability company. The limited liability company structure boasts many advantages, but also brings with it some disadvantages to consider.
Limited Liability Companies, Generally
First, the different between a legal entity and a tax entity must be discussed. Often, new entrepreneurs get these two concepts confused. A tax entity classification is simply the way the IRS and the state taxing board sees the business. The legal entity classification is how courts, states, and contractual partners see the business. For example, a corporation (its legal identity) will be given a corporation tax designation like C-corporation or S-corporation (its tax identity). However, an LLC has a choice on what tax identity it will have. An LLC can be seen as a partnership or as a C-corporation or an S-corporation. There is no true LLC tax identity, thus, an LLC is seen as one of the traditional tax entities instead. Therefore, an LLC has greater flexibility and can choose the tax identity that most benefits its members.
Among the business entities, some offer high liability protection, like the corporation, and others offer no liability protection, like the partnership. Limited liability companies are middle of the road, meaning the LLC protects an owner from personal liability, but offers less protection than a corporation. Both LLCs and corporations offer protection from personal liability, but LLCs avoid double-taxation, to which C-corporations are subject. Owners of an LLC, called “members,” are taxed as sole-proprietors, which means that the business’s income passes through to the members’ personal income taxes.
The laws surrounding LLCs differ from state to state. Attempting to comply with all of the different laws of each state can be intimidating and overwhelming. Further, members must be aware that non-compliance with laws and regulations concerning LLCs may expose you, your family, and your business to serious risk. Hiring an attorney when deciding where and how to form your company is very important. It is critical to do your research, learn as much as possible, and become informed before you decide which business structure is right for you.
LLCs offer owners many advantages, and most entrepreneurs should highly consider structuring their new business as an LLC.
Members’ liability for debts and obligations of the LLC are limited to the member’s own investment. Stated differently, if your LLC gets sued for any reason, your personal assets, bank accounts, and real estate are protected. The most a member can lose is the money the member invested into the company, and nothing more.
A major difference between an LLC and a corporation is the liability protection. The members’ liability is only to the extent of its investment. In most states, a creditor cannot reach a member’s distributions from the LLC. With a corporation, a creditor cannot collect a shareholder’s personal assets, but may collect the shareholder’s distributions, which take the form of dividends.
However, the LLC does not offer blanket protection. Members may still be liable for criminal behavior or it they neglect to follow certain rules about business management. Make sure to consult a lawyer to ensure you do not violate these rules and expose yourself to personal liability.
Both S-corporations and LLCs benefit from pass-through taxation. Pass-through taxation means that the company’s income is passed through to its members or shareholders so that they are taxed at the end of the year but the company is not. See Daniels v. Fla. Dep’t of Health, 898 So. 2d 61, 64 n.4 (Fla. 2005). This is unlike C-corporations, which endure double taxation, meaning the company is taxed on its income and then its shareholders are taxed on the income which they receive through dividends. Id. Thus, the income from your LLC may be treated as your own personal income, and is therefore not subject to certain federal taxes for which corporations are liable.
No Limit to Ownership
Some legal structures limit the number of people that may file as owners. With an LLC, there is no limit to the amount of owners; an LLC can have one member, or it may have hundreds of members. More interesting about the freedom of ownership associated with LLCs is that, unlike Florida S corporations, Florida LLCs are allowed to own subsidiaries without restriction.
Unlike corporations, LLCs are not required to have annual meetings, a board of directors, or strict book-keeping requirements. Further, the LLC structure does not require corporate minutes or resolutions. This means that you can run your business on your own terms, without a lot of the added stress that comes with dealing with a board or shareholders.
Even though there are very enticing advantages in structuring your business as an LLC, there are considerable disadvantages one must acknowledge before choosing the LLC structure for your new business.
Unlike corporations that issue stock in order to raise funds for their companies, LLCs must work harder to find investors and sources of capital due to the greater legal requirements and state filings involved to add a new member of an LLC. For an example of just how overwhelming the amount of legal requirements for an LLC are, look to Florida’s Revised Limited Liability Company Act, found at Chapter 605 of the Florida Statutes. If you have a fast growing company and need venture capital immediately, this constraint is one of the biggest disadvantages of an LLC.
LLCs typically are faced with hire fees to file as an LLC as compared to other business structures. Further, some states require yearly renewal fees. You can find a list of all fees LLCs are subject to in Florida at Florida Statute § 605.0213.
Limited Flexibility in Ownership Transfers
Ownership in an LLC is typically harder to transfer than ownership in a corporation. The members must consult the LLC’s operating agreement and determine whether or not ownership can be transferred. If one of the LLC members’ ownership is allowed to be transferred, it must also be stated in the operating agreement whether approval of the other members is required. See Florida Statutes §§ 605.0106, 605.0401, 605.0501, and 605.0502 for the rules regarding becoming a member of a new or existing LLC, and transfers of an interest in the LLC.
Lack of Case Law
The LLC business structure is a relatively new concept. Thus, not a lot of case law has developed regarding LLCs. Case law is crucial because of predictability and consistency. If you know that a court has ruled a certain way, you can act accordingly to protect yourself. However, if few cases have been decided, there is a level of uncertainty and vulnerability with the operations of your LLC that could expose you to greater liability.
Confusion across State Lines
Rules regarding LLCs differ from state to state. If you decide to start doing business in multiple states, it could become difficult to understand and comply with all of the requirements of each state, and in some cases it may be necessary or preferred to form subsidiary entities to operate in other states.
Learning how LLCs function and comprehending the critical advantages and disadvantages of a limited liability company are important steps in the path to starting your own successful business. By properly planning and structuring your company early in the start-up process, you have better odds of success and could quite possibly assist your company in avoiding lawsuits, disagreements, and other legal issues in the future. Hiring an attorney when deciding where and how to form your company is also a crucial step. But further, it is critical to do your research, learn as much as possible, and become informed before you decide which business structure is right for you.