LLCs are a popular choice when it comes to forming a business. The flexibility and tax advantages it offers prove to be an attractive option for big and small businesses alike.
If you are launching a startup, forming an LLC can be a great choice to launch your business in the right direction.
Read on to learn everything you need to know about forming an LLC for your startup business.
What Is an LLC
First and foremost, let’s define what an LLC is to get a better understanding of what we’ll be discussing. An LLC (Limited Liability Company) is a legal business structure that provides liability protection to its owners while offering the flexibility of a partnership — making it easier to manage and legally secure.
Here are the main factors of an LLC:
- A type of business structure that offers legal and financial protection to its owners, known as members
- Members are not personally liable for any debts or legal liabilities incurred by the company
- LLCs provide a level of protection to business owners while still allowing for flexibility in management and taxation
- LLCs can help to legitimize your business and make it more viable for investors and to apply for business loans
These are the fundamentals of an LLC, but there are many other aspects to know if you wish to have a successful and compliant startup business. For further clarification, read more about the functions of an LLC in detail here.
When Should You Consider an LLC for Your Startup
There are several reasons for choosing an LLC for your startup. How you choose your business structure depends largely on the nature of your business, its location, and the legal obligations of your business. In this section, we’ll go over some of the top reasons why you should consider an LLC for your startup.
If your business is sued or incurs debt you cannot pay, the LLC protects your personal assets from the remaining financial burdens. Having a separate entity is beneficial in this regard and can save you a lot of time and money if you determine your liability protection from the beginning.
One of the main reasons people choose an LLC as a business structure is the tax advantages. There are many deductions for your business expenses, and you can avoid double taxation, unlike a corporation. Also, if you’re a sole proprietor and want liability protection for your finances, choosing an LLC can be a wise decision for your business.
Ownership of an LLC may be divided among several individuals, and the entity may have different levels of management. This allows LLCs to be tailored to a company’s individual needs, making them an attractive option for startups that want more control over their ownership and management structure.
Advantages of an LLC
Now that you know what an LLC is and what to consider, let’s explore some of the benefits of forming an LLC.
In this section, we’ll get into more detail about each of these benefits and help you decide if an LLC is the right choice for your startup.
One of the major advantages of forming an LLC for a startup is the tax benefits it can provide. LLCs offer pass-through taxation, which means that the company itself does not pay taxes on its income.
Instead, any profits or losses are passed through to the individual members of the LLC and are taxed as personal income on their individual tax returns.
This can be a significant advantage over a corporation, which is subject to “double taxation” on the corporate level.
Less Complex Company Structure
LLCs combine elements of a corporation and a partnership or sole proprietorship — forming a simplified structure that requires fewer formalities than a corporation.
LLCs also don’t require annual meetings or as extensive recordkeeping as a corporation, which can save time and resources for startups.
In addition, LLCs offer more flexibility in management because they can be structured to meet the individual needs of the business and its owners.
This simplicity in a corporate structure can be an advantage for startups that want to focus on growth and development rather than administrative tasks.
Flexibility in Accepting Certain Types of Investments
LLCs also offer a unique advantage when it comes to accepting certain types of investments. While corporations may need to be restructured to accept investments such as venture capital, LLCs offer more flexibility in this regard.
LLCs also show the legitimacy of a company and are considered reputable in the eyes of the IRS. Therefore, companies operating under an LLC have a better chance of obtaining business loans from banks and other financial institutions.
Steps in Forming an LLC
If you’ve decided that forming an LLC is the right choice for your startup, there are some important steps you need to take. From choosing a name to filing articles of organization to drafting an operating agreement, forming an LLC can be a complex process. But if you follow these steps and consult with legal and tax professionals, you can set your startup up for success.
Here are the steps you need to take to form an LLC:
- Choose a business name for the LLC
- File the necessary paperwork with the state
- Obtain any necessary business licenses and permits
- Open a business bank account for the LLC
- Obtain any necessary insurance for the LLC
Depending on the nature of your business and what types of legal requirements you need, the steps above may vary.
In general, this is what you will need to keep in mind when developing an LLC.
To learn more about setting up your LLC, check out this video to get started.
Disadvantages of an LLC for Startups
While forming an LLC has numerous advantages for startups, there are also some potential disadvantages to consider. Here are some of the disadvantages of an LLC for startups:
Forming an LLC can be more expensive than other business structures, such as sole proprietorships or partnerships. LLCs may also require filing fees, legal fees, and ongoing maintenance costs that can add up over time. In some states, LLCs may be subject to annual fees or franchise taxes which can increase the overall cost of maintaining the business as well.
LLCs can be restrictive in terms of ownership and management. While LLCs offer flexibility for owning and managing, they also have restrictions on the number of members and the types of members permitted. This can limit a startup’s ability to bring in new investors or partners — restricting the company to allow different levels of ownership or management.
LLCs may have limited access to certain types of investors or funding sources. Venture capitalists, for example, prefer to invest in corporations rather than LLCs because corporations provide more structure and a clearer path to exit strategies. LLCs may also not be able to issue stock or use other funding sources available to corporations. This can limit a startup’s overall growth potential.
Depending on the priorities of your business and how it’s operated, there may be several reasons not to use an LLC as a business structure. Thorough research into the different types of business formation can ensure that you make the right choice for the success of your business.
C-Corporation as an Alternative Entity Type
While LLCs are a popular choice for startups, C-corps are also a viable alternative entity type. A C-corp can offer similar advantages as an LLC. i.e. limited liability protection and tax benefits — also providing additional benefits such as the ability to issue stocks and attract more diverse types of investors.
Moreover, C-corps may be a better fit for startups that anticipate significant growth or plan to go public in the future. While there are some additional requirements and formalities associated with forming and maintaining a C-corp, it may be a better choice for startups with long-term growth goals.
Navigating the Legal Landscape of an LLC
Forming an LLC for your startup can provide numerous benefits, such as limited liability protection and tax flexibility.
But navigating the legal landscape of an LLC can be complex, and it’s important to ensure that you comply with all relevant laws and regulations.
This is where doola’s bookkeeping services can help. Our experienced team can guide you through the process of forming an LLC, including selecting a name, filing articles of organization, and drafting an operating agreement.
We can also provide ongoing bookkeeping and accounting services to help ensure that your LLC remains in compliance with all legal and tax requirements.
Contact us today to learn more!
Do you need an LLC for your startup?
The decision to form an LLC for a startup depends on several factors, such as personal asset protection, tax advantage, and management flexibility. It’s important to consider these factors and consult with legal and tax professionals before making a decision.
How long does it take to get an LLC?
The time it takes to form an LLC varies by state, but it typically takes between one to six weeks to complete the process, including filing articles of organization and obtaining necessary permits and licenses.
Do big startups start as anLLC?
Big startups have the option to start as LLCs and have the potential to grow into successful companies like Goldman Sachs, Uber, or Trader Joe’s.
Do startups convert from LLCs to corporations?
Yes, it is not uncommon for startups to convert from an LLC to a corporation as their business grows and evolves. This may be necessary to take advantage of certain investment opportunities or to prepare for an eventual IPO (Initial Public Offering)
Do LLC members need equal cash contributions at startup?
No, certain LLCs can function under an operating agreement in which one member is the primary investor while the other is the primary manager for business operations.
Are LLC startup costs tax deductible?
Yes, the startup costs of forming an LLC, such as legal and filing fees, are generally tax deductible as long as they’re incurred in the same tax year in which the LLC is formed. However, there are limits and special rules on how these expenses can be deducted.