Advantages and Disadvantages of LLCs

A LLC is a blend of protection, flexibility and simplicity which is offered by incorporating both the features of sole proprietorships and corporations. Nevertheless, as a business structure, it has its benefits as well as drawbacks.

A breakdown is provided below to make you decide whether you should form an LLC or not depending on your business.

What Is an LLC?

Limited Liability Company (LLC) is a legal business entity that dissociates individual assets of the owner and business liabilities. This implies that, should the business be sued or fail to meet its debt repayments, the personal properties of the owners including their house or personal savings are usually secured.

The tax flexibility of LLCs is also a known fact. An LLC by default is a pass-through entity, i.e. the business itself is not taxed paying federal income taxes. Rather, profits and losses are transferred to the owners (referred to as members and claim them in their individual income taxes).

Flexibility of management is another characteristic of LLCs. In comparison to corporations, LLCs do not have to associate themselves with inflexible management models and, therefore, they are particularly appealing to startups and small-scale companies.

Benefits of LLC Formation

1. Uncomplicated Formation and Government

In comparison to corporations, LLCs have less structure and are relatively easy and inexpensive to form and maintain. They also do not need the presence of a board of directors in addition to a shareholder meeting, as well as complicated corporate bylaws.

Although in the majority of states the LLCs are obliged to submit the annual or biannual reports, the whole administration burden remains lower than in corporations, which is why LLCs are easier to manage by the small business owners.

2. Management and Control Flexibility by the owner

Members of LLC are fully in control of the management of the business. They have the option of operating the company or hiring managers to handle the daily operations of the company.

In comparison to corporations where the executives report to a board of directors, LLC owners do not necessarily report to external decision-makers unless they decide to do so.

3. Limited Personal Liability Protection

Protection of limited liability is one of the greatest benefits of LLC. The owners are considered as distinct legal persons not the business, and the individual assets are not exposed to most business-related debts and lawsuits.

Nevertheless, this safeguard is not complete. The proprietors can also remain personally liable when all they do is:

• Personally guarantee a loan
• Fraud and or illegal activity.
• Do not establish a distinction between personal and business finances.

The protection of LLCs is relatively high as compared to sole proprietorships where all the business functions are borne by the owner himself.

4. Flexible Tax Options

By default:

• A single-member LLC is similar to the sole proprietorship in taxation.
• Multi member LLC is taxable as partnership.

In both instances, profits are distributed to personal tax returns of the members.

The characteristic of LLCs is that they have an opportunity to choose another tax status. The members have the option of being taxed as:

• A C Corporation
• An S Corporation

By electing S Corporation status, the owner can save on taxes on self-employment because, in this case, owners are allowed to pay themselves a reasonable salary and then take the rest of the income as distributions. This however comes with other payroll and accounting costs hence only makes sense when tax savings exceed extra expenses.

5. Adjustable Profit Distribution

In contrast to corporations, the shares of which are distributed among others only according to their share ownership, LLCs enable the members to determine the way in which they split their profits.

The profit-sharing regulations are described in the operating agreement of the LLC and can be crafted in any manner the members see fit. As an illustration, a member can have a higher share of profits because he/she is more involved in the day to day running of the company, even though he/she has a lower number of shares in the company.

6. Greater Business Credibility

Being a LLC might bring a business closer to seeming professional and well-established. Contrary to sole proprietorships in which the business name is usually the personal name of the owner LLCs may adopt a special business name, which may be more credible with customers, suppliers and lenders.

Cons of Commencing as LLC

1. Unappealing to Investors

The investors do not always prefer LLCs. The shares that are being issued by corporations can be transferred easily and that is why they are more attractive to venture capitalists and angel investors.

The membership percentage of a LLC is considered as ownership but not in the form of shares, which may complicate the process of transferring partly ownership. Therefore, companies that intend to attract large amounts of external capital tend to select a corporate design in its place.

2. Taxes on Unresponsible Profits

The members of the LLC will be subject to taxes on their portion of business profits, even when it is not paid out.

As in, a profit of 100,000 is subject to taxation as only in case of an LLC making 50,000 in income, the members are taxed on the entire 100,000. This may bring some cash-flow difficulties to owners.

3. Expensive compared to Sole Proprietorships

Even though LLCs are not as expensive as corporations, they are also still more expensive than sole proprietorships or general partnerships.

LLCs typically require:

• Formation State filing fees.
• The Annual or periodic report fees.
• Costs registered agent (in certain states)

Partnerships and sole proprietorships do not normally need any formal registration in the state hence they are less expensive to run.

Conclusion: Are You a Good LLC?

The LLC is a good option to most small-business owners since the protection of the liability, flexibility in taxation, and manageability make it a good balance. Specifically, it is effective when a businessperson needs protection without complications seen with a corporation.

But, when you intend to raise an outside investment, issue share, or take your company to the market, a corporate structure can be more preferable.

It is prudent to first seek advice of a legal or tax professional before establishing an LLC to make sure it fits in your financial objectives and long-term objectives.