When Should I Form an LLC: Everything You Need to Know
Understanding LLCs will help you know when to convert a sole proprietorship or a partnership. Or, if you are starting a business, you may want to form an LLC.3 min read
Wondering "when should I form an LLC" is understandable. The different business structures can be confusing. Forming an LLC can also be intimidating to a new business owner. LLCs are flexible by nature, but it is the same flexibility that can make creating your LLC challenging. Understanding an LLC will help you know when to convert a sole proprietorship or a partnership to an LLC. Furthermore, if you are thinking about starting a business, you may want to form an LLC for your new venture. Not all businesses qualify for the LLC structure, so it is important that you understand when (and if) you should form an LLC.
What Is an LLC
An LLC is an abbreviated way to reference a limited liability company. An LLC joins desirable features of a sole proprietorship, a partnership, and a corporation. The LLC structure was formed in the 1970s to help small business owners minimize risk associated with their businesses. An LLC has the following characteristics:
- LLC owners are called "members." An LLC with one owner is a single-member LLC. Conversely, an LLC with more than one owner is known as a multi-member LLC.
- Just as a corporation limits its shareholders' liability risk, so does an LLC. Limited liability companies give its members liability protection. Under normal circumstances, a creditor cannot seize member assets to satisfy the LLC's debt.
- By default, an LLC's tax treatment mimics a sole proprietor or partnership's tax treatment. Income and losses pass through the entity to the members; therefore, LLCs are not subject to double taxation like a standard C corporation.
- LLC members have flexibility in how they run their business. If LLC members choose to run the business themselves, then it is member-managed. Sometimes an LLC has at least one passive member. A passive member is a member that does not participate in managing the day-to-day operation. There are also situations where LLC members may choose a non-member to manage the business. A manager-managed company is one that has at least one passive member, a non-member operating the business, or a combination of both.
How to Set up an LLC
LLCs, like corporations, must file with the secretary of state or whatever state office is responsible for overseeing business structures. First, you must select your business name. Consider the following when deciding on a business name:
- It must be unique and cannot be too similar to any other business registered in the state.
- It cannot infringe on existing copyrights.
- It cannot include restricted words like “Bank “or “Insurance.”
- It needs to include the limited liability company in its name, such as LLC, L.L.C, Ltd Co, etc.
Check with your state office to find business name rules.
You must submit your articles of organization, which includes the business's name and address, information for each member, and your registered agent information. The registered agent is the person who will receive legal documents as well as documents from the state regarding your business. Make sure they are available during regular business hours.
Some states require you post a public notice in the paper announcing your intent to form an LLC. You will need to publish it for a specific amount of time. Your local newspaper can help you with this process.
While it is not mandated, you should create an operating agreement to outline the rights of each member, document member-interest, and detail business management policies.
Who Should Form an LLC?
If you like the ease of running a sole proprietorship or a partnership but need liability protection, then you may want to consider forming a limited liability company. An LLC will allow you to protect your assets while giving you the flexibility to structure your operations at your discretion.
Unfortunately, not all businesses qualify for LLC formation. Banks, trusts, and insurance businesses are prohibited from forming an LLC. Additionally, some states prevent professional service-oriented companies, like a doctor's office or a law firm, from forming an LLC.
An LLC is usually an excellent business entity for many small business owners. Check with your state office regarding the rules and guidelines for forming an LLC in your state and make sure an LLC structure is right for your business needs.
If you need help forming an LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.