What is a Limited Liability Company (LLC)?
The LLC is a relatively new form of business entity offered by most US jurisdictions that aims to provide the separate entity and limited liability benefits of a corporation while preserving the pass-through tax benefits of a partnership or sole proprietorship. In addition, it offers more flexibility in management than a corporation does.
The owners of an LLC are referred to as “members”, and the members typically agree on the management and relative rights to the proceeds of the business by agreeing to an operating agreement. An LLC offers greater flexibility to the managers and investors by allowing the operating agreement to govern the entity, but this can create complications and uncertainty unless the operating agreement is carefully drafted.
Additionally, an LLC offers less certainty to investors than a corporation, because the flexibility is at the expense of certain statutory protections for minority shareholders in a corporation. Savvy investors are unlikely to invest in an LLC.
Technically, a company can initially be structured as an LLC and then convert to a corporation once there is a capital investment on the table, however this can create complications in the initial capitalization structure. However, if there is only one member (i.e., there is only one owner), it might make sense for a number of tax reasons to operate as an LLC for some time and then transfer the assets to a new corporation once there is investment.
Is a Limited Liability Company right for my business?
Generally speaking, an LLC can be a good option for small or start-up businesses under certain circumstances. The pass-through tax benefits and flexible governance make it a desirable entity structure, but only if the LLC will be closely-held and if the business will not be seeking equity financing.
One thing to consider is the state tax impact of an LLC as compared to a corporation, as different states tax LLCs differently than how they tax corporations. For example, a California LLC is subject to an annual $800 “minimum franchise tax” regardless of revenues or profits or any income tax it might pay, and California corporations and LLCs are taxed differently for both income and franchise taxes. A careful assessment needs to be made by your legal and tax advisors in order to determine where to form an LLC or incorporate, and which entity would be more beneficial.