Unlike a sole proprietorship, a Limited Liability Company (LLC/) does offer some protection from liability, and yet you still have the ease of a pass-through taxation scenario as you would with a sole proprietorship. Versus establishing a corporation, forming an LLC is going to be the simplest option when it comes to setting up an entity that offers certain protections in terms of personal assets. It can either be owned by one person or multiple owners; these are referred to as a single-member LLC or a multi-member LLC. In this article, we take a closer look at what an LLC entails along with some of the pros and cons of establishing one.
Why Set Up an LLC?
In some cases, it is going to make more sense to set up an LLC instead of simply running your business as a sole proprietor. Among the key reasons for having it is that it does protect your assets. So for example, if the company is involved in a lawsuit, you are not personally on the hook as far as any damages are concerned. And as mentioned, over a corporation, the process of creating an LLC is much easier without a ton of paperwork involved. With some corporate structures, the business gets taxed twice. Because it has passed through taxation, you're only taxed once. Also, with an LLC, there is the credibility factor that you may not get with a sole proprietorship; in other words, the company appears more professional to consumers.
For some entrepreneurs, an LLC provides the perfect mix of both protection and ease of formation.
Some Advantages
Beyond the simplicity of setting up an LLC and the protections it does offer to the business owner, several things make an it fairly attractive and thus consideration for many business owners:
Limited Liability Protection
Barring any sort of fraud or illegal activity, an LLC does protect its members from legal action, safeguarding their assets. If a company does get sued or has accrued debt, the owners of the company are not responsible for paying. Creditors cannot go after members' personal property, cash, or any other such investments.
Pass-Through Taxation
Unlike a corporation, the profits from an LLC go directly to the owners of the company. This then gets reported on their tax returns. Because of this, business income is only taxed once. With a C Corp, for example, there is double taxation, meaning, the business profits are taxed and then the income paid to owners is also taxed. This double taxation is avoided when you create an LLC.
Flexibility
An LLC offers quite a bit of flexibility when it comes to how ownership and management of the company are structured. There are a few things however to keep in mind. With a multi-member LLC, members can manage the company; this is referred to as member-managed. The other option available is for the members to appoint a manager to run the company, known as a manager-managed firm.
Tax Options
In setting up an LLC, you have the option of how you want income to be taxed. Many will opt to be taxed as an S Corp. While this is a business entity in and of itself, an S Corp taxation option is available to LLCs.
Increased Credibility
As previously mentioned, by establishing your company as an LLC, you immediately up the credibility factor. This is a more formal structure than a sole proprietorship and as such, consumers tend to feel more comfortable working with LLCs over just a sole proprietor.
Business Funding
The establishment of an LLC helps you to begin building up your business credit. As you gain credit history for your LLC, you become a more viable candidate for business loans and certain types of commercial funding.
Some Disadvantages
There are some cons involved with the creation of an LLC. While not major disadvantages, some things to keep in mind as you decide what type of business structure you want to set up:
Lack of Investors
While it's not impossible to get investors interested in your LLC, the structure is not as attractive as a corporation would be for those looking to invest.
Startup Costs
Versus a sole proprietorship, it is going to cost more to form and operate. However, the costs will not be as much as if you were to create a corporation.
Unemployment Compensation
Yes, with an LLC you do get the benefit of having a pass-through taxation scheme, that said, owners also have to pay unemployment compensation on themselves. As a sole proprietor, this generally is not the case.
Record Keeping
Because it does offer personal asset protection and the company is treated as an entity separate from the members, record keeping has to be thorough to this end. There must be a diligent separation of personal accounts and business accounts, otherwise, this could create issues down the road.
Establishing an LLC, while a bit more complex than setting up a sole proprietorship, is still not as difficult as you may think. This is why many business owners do opt to create an LLC and thus benefit from the protection that this type of entity does offer. And of course, rather than spending thousands setting up a corporation, not to mention the time and energy involved, setting up an LLC is much easier and more cost-effective, especially for businesses just starting. You need to carefully weigh the pros and cons to determine if this business structure makes the most sense for you.
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