Questions to Ask When Starting an LLC
Are you interested in starting your first business and escaping the rat race? Then you’ve probably thought about forming an LLC.
Most new entrepreneurs decide to start their first business as an LLC, and it’s not hard to understand why. Setting up your business as an LLC not only safeguards your personal assets, but it can also help you establish a professional reputation.
But while the decision form an LLC may seem simple, entrepreneurs often overlook key considerations when choosing the right business structure. Here’s a list of questions to ask before forming an LLC, to help you avoid common mistakes.
LLC Questions and Answers
What is an LLC, and how does it differ from other business structures?
An LLC (a.k.a. limited liability company) is a type of business structure. With an LLC, entrepreneurs get the best of both worlds. They get the management flexibility of a partnership or sole proprietorship, and the liability protection of a corporation.
LLCs are similar to corporations because they are separate legal entities from the people who own them. As a result, the owners of an LLC (a.k.a. members) are generally not responsible for the debts or liabilities of the LLC. Thus, LLC owners are able to protect their personal assets (e.g., home, car, bank accounts, wages) from the risks associated with doing business.
LLCs differ from corporations because they do not have to follow the same corporate formalities. While control of a corporation belongs to the board of directors, LLCs have more flexibility. Control of the LLC can rest with the members or with a group of chosen managers. Also, in most states, LLCs aren’t required to hold meetings and have looser record keeping requirements.
The management flexibility of an LLC is similar to a partnership or sole proprietorship, and makes LLCs relatively easy to manage. Partnerships and sole proprietorships are not separate legal entities though. As a result, they do not grant their owners any type of personal liability protection.
What are the basic steps to set up an LLC?
While the details may vary from state to state, there are 4 basic steps to setting up an LLC.
- File your certificate of organization with the state in which you plan to form your LLC. This step creates your LLC. Typically, you can do this online. Turn around times vary from a few days to a few weeks, so plan accordingly.
- Apply for an EIN (employer identification number) from the IRS. An EIN is like a social security number for your company. The IRS, Department of Revenue, and other agencies will use it to identify your business for tax purposes.
- Draft and execute your operating agreement. If you have a business partner, this step is absolutely critical. Even if you don’t, you’ll still need an operating agreement to complete the next step.
- Open a business bank account. Mixing business funds with personal funds is the easiest way to lose your liability protection. So setting up a business bank account is essential. To learn more about the importance of a business bank account and choosing the right bank, check out this free guide.
What state should I set up my LLC in?
You may have heard that it’s best to set up your LLC in Delaware (taxes) or Wyoming (privacy). However, the state you live and/or operate the business in is probably the best state to form your LLC. The reason is simplicity. Let me explain.
Let’s say you operate an e-commerce business in Pennsylvania, and you decide for form your LLC in Delaware. Since you run the business from home, you’re still required to register it in PA. So now you have to maintain your LLC in two states, which means double the fees, double the forms, etc. Furthermore, your business could be sued in Delaware even though you don’t live or do business there.
For most small business owners, it’s best to keep it simple and set up an LLC in their home state. However, you should base this decision on your unique circumstances. Talk to your attorney before deciding for yourself.
Who are the members in an LLC?
The members in an LLC are the owners. They are the individuals or entities who have a financial interest in the LLC. Members typically have certain rights and obligations as it relates to the LLC.
Generally speaking, members in an LLC have the right to:
- Share in the profits of the LLC
- Control the LLC (unless it is manager managed)
- Inspect LLC records
- Receive indemnity from the LLC against lawsuits related to their actions as a member
- Enter legally binding agreements on behalf of the LLC
Conversely, members must:
- Make an initial contribution to the LLC in exchange for membership
- Remain loyal to the LLC
- Act in good faith
LLC membership rights and obligations are not the same in every state. Furthermore, the LLC operating agreement can alter or eliminate many of them. So take care in how you craft your operating agreement.
Who are the managers in an LLC?
The managers play a similar role as the executives (CEO, COO, etc.) in a corporation. They are generally responsible for implementing strategy and managing the day to day affairs of the LLC. Managers may be members of the LLC. But they can also be independent professionals with no financial stake in the company.
Not every LLC has managers. Many LLCs are member-managed, meaning the members have the right to manage day-to-day affairs. Choosing managers to run an LLC tends to make the most sense when:
- Some of the members don’t want to play an active role in managing the LLC
- Certain members possess skills that make them particularly well suited for specific roles
- Member’s wish to appoint an outside professional as a manager
Members can make their LLC member managed using their operating agreement. In a manager-managed LLC, the operating agreement will name the managers and outline their specific duties. In some states, the LLC is required to state its management structure when forming the company.
What if a member dies or wants to leave the LLC?
You must address this issue in the LLC operating agreement based on what is best for your circumstances. It is much easier to address the death or exit of a business partner when there’s a clear plan in place.
One of the best ways to deal with the death, disability, or exit of a member is with a buy-sell agreement. A buy-sell agreement is a contract between business owners that outlines the terms and conditions for buying or selling a partner’s share in the company. Here’s how it works.
The company purchases a life insurance policy on each of the members. If one of the member’s dies, this triggers the buy-sell agreement in the company’s operating agreement. The deceased member’s estate is required to sell their membership interest back to the company. And the company will use the proceeds from the life insurance policy purchased on the deceased member to compensate their estate.
This is a win-win for everyone. The remaining business partners don’t have to worry about working with a new business partner, and the heirs of the deceased member receive financial compensation from the legacy built by their lost loved one.
Can I move an LLC from one state to another?
Yes. If you are moving from one state to another, there are a few different ways to set your business up in your new state.
If you’re moving temporarily, you may choose to keep your LLC in your home and register it as a foreign entity in your new state. For example, let’s say you’re a military spouse and you’re PCSing to a new state, but you’re planning to return to your home state eventually. Registering your LLC as a foreign entity in your new state would allow you to do business there, without changing your LLC’s state of origin. You can also choose to register your LLC as a foreign entity if you are moving permanently. The downside would be that your LLC will still have to comply with the requirements of your state of origin.
Alternatively, you could completely change your LLCs state of origin. The easiest way to do this is through domestication. Domestication is a process where you change your LLCs state of origin by completing the proper paperwork with your new state. This would allow you to officially move your LLC from one state to another.
Unfortunately, not every state offers a domestication process. In those cases, you’d need to create an LLC in your new state and: (a) dissolve the LLC in your old state or (b) merge your old LLC with your new one.
Each of these approaches has advantages and disadvantages. Talk with your lawyer to figure out which would be best for you.
What is an operating agreement?
An operating agreement is an agreement between the members of an LLC, that provides a framework for how the company will be run. It typically covers. a range of important topics including profit sharing, contribution requirements, decision making authority, voting rights, and procedures for removing and admitting new members.
While a written operating agreement is not required in most states, it is an essential document for two main reasons. First, it helps LLC members avoid misunderstandings that can lead to conflict, increasing the likelihood of success. Second, it is a required document for opening business bank accounts, obtaining a loan, and purchasing certain assets (like real estate).
If you do not create your own, the law in the state where your company was formed will serve as your LLC’s operating agreement.
Can I change from an LLC to another business structure?
Yes, you can change your LLC to another business structure.
If you are looking to convert your LLC into a corporation, you have two options (depending on the state).
Some states have a process called statutory conversion. This process allows a company to convert from an LLC to a corporation by filing the appropriate paperwork.
If your state does not have a statutory conversion process, you may have to create a corporation and then either: (a) dissolve your LLC and transfer it’s assets to the new corporation or (b) merge the LLC into the corporation (making the LLC a subsidiary of the corporation).
Of the two approaches, statutory conversion is typically preferred because it is simpler and allows for greater continuity.
If you want to convert your LLC into a sole proprietorship or a partnership, you have one option. You will need to dissolve your LLC, and transfer ownership of its assets.
Be aware, that changing your business structure is not same thing as changing the tax status of your LLC. The IRS does not have a separate tax category for LLCs. By default, LLCs are either treated as sole proprietorships or partnerships depending on the number of members. But an LLC can also elect to be treated as an S-Corp, C-Corp, or even a nonprofit if it meets certain requirements. If you want to change the tax treatment of your LLC, that may be accomplished by filing the appropriate paperwork with the IRS without changing the actual structure of the business.
How would I shut down my LLC?
To shut down an LLC, you will need to dissolve and terminate it. The steps to accomplish this may vary from state to state. But generally speaking, the process looks like this:
- The members pass a resolution to dissolve the LLC.
- The company files an articles of dissolution and closes out its businesses permits.
- Notify any creditors of the company’s dissolution.
- Develop a plan to settle any outstanding debts.
- File a final tax return and related partnership forms.
- Apply for tax clearance certificate(s).
- Contact the IRS to close out your employer identification number (EIN).
- Process final wages and compensation for your employees.
- Distribute any assets (such as property owned in the name of your LLC).
- Conduct other finalizing processes. This includes closing all bank accounts and cancelling any insurance policies, licenses, permits, or registrations the LLC holds. Make sure to keep a copy of the LLC’s records somewhere safe for seven years. This is a preventative measure in case there is ever an audit.
Is the name I want for my LLC available?
To see whether the name you want for your LLC is available is simple. You will need to check your state’s business entity database.
The easiest way to accomplish this would for you to search for “[insert your state here] business entity search.” Once the results load, head over to your state’s government website and enter your desired name in the search box.
What are the annual reporting requirements?
States create their own annual reporting standards. You should visit your state’s business filing website for due dates, filing fees, and required information about your business.
What are the typical advantages of structuring my business as an LLC?
Generally speaking, the advantages of the LLC structure are:
- Limited liability. An LLC protects its owners from having personal responsibility for a company’s liabilities.
- Flexible management arrangements. Members of the LLC can either manage business or elect a management group to do so.
- Choice of tax treatment. An LLC can be treated as a sole proprietorship, partnership, S-Corp, C-Corp, or even a nonprofit.
- Heightened credibility. LLCs give new businesses more credibility than a sole proprietorship or partnership.
- Ease of set up.
What are the typical disadvantages?
- Costs. An LLC usually requires more money to form and maintain compared to a sole proprietorship or a general partnership. This includes startup fees and annual/ongoing fees. Fees can vary between states so be sure to check your state’s Secretary of State’s website.
- More responsibility tha people realize. An LLC is a legal entity, and it comes with legal responsibilities. Aspiring business owners should make sure they are ready to commit to maintaining their LLC before forming it.
Will an LLC protect my personal assets from risk?
Personal liability protection is one of the main reasons entrepreneurs choose to form their business as an LLC. Generally speaking, business owners are protected from the liabilities of their LLC. However, this layer of liability protection is not absolute.
An LLC will not protect you from your own negligence. For example, if you are texting and driving the company van and you hit someone, you may be held personally liable because your unreasonable behavior caused harm to another person.
Business owners can also lose their limited liability protection. This occurs when a court decides to remove the company’s personal liability protection, and is known as piercing the corporate veil. This most commonly occurs when business owners commingle funds. In other words, when business owners treat assets that belong to the business, as if they belong to the business owner. Since the business owner is not respecting the legal separation between themselves and the company, the court refuses to do so as well, allowing the company’s creditors and claimants to collect from the business owners’ personal assets. The easiest way to avoid this fate is to open a business bank account to manage business funds.
Are there any tax benefits to having an LLC?
One of the benefits of having an LLC is that you have choice of tax treatment. The IRS does not have a separate tax category for LLCs. The IRS will treat them as sole proprietorships or partnerships by default, depending on the number of business owners. However, you can also select treatment as an S-Corp, C-Corp, or even a non-profit.
Entrepreneurs who elect tax treatment as an S-Corp may be able to recognize tax savings by avoiding self-employment taxes. However, this change will most likely subject the company to state corporate taxes. Talk with your tax professional about the most advantageous strategy from a tax perspective.
Do I need an attorney to set up my LLC?
You do not need an attorney to set up an LLC. Anyone can do it, provided they have the time and patience to research the proper steps. However, setting a proper legal foundation for you new business is about more than just creating an LLC. Experienced CEOs understand that success also requires:
- Contracts that establish trust between business owners and their key partners and contractors
- Trademarks, copyrights, and patents that unlock their ability to leverage their intellectual property
- Tax planning to ensure they keep more of their hard earned dollars
- Insurance to protect against worst case scenarios
For a new entrepreneur, addressing each of these issues can be scary. Which is why we created our signature LLC Formation Packages. MZA Legal’s LLC Formation Packages make it simple to address every aspect of a solid legal foundation for one clear price.
It’s never been so simple to work with a legal professional and get the support you need to launch your new business or side hustle. Schedule a free discovery call to learn more.