Heads up: this article is only relevant for U.S. businesses.
If you’re new to the business world and thinking about forming a limited liability company (LLC), this guide will walk you through the process.
Before diving into the specifics of how to form an LLC, let’s look at the pros and cons of this popular business structure.
Advantages of an LLC
One of the best-known benefits of forming an LLC is the personal liability protection it affords to business owners. As the owner of an LLC, your personal assets (such as your bank account, car, and even your home) are protected in the event of a lawsuit or debt incurred against your business.
Often, this liability protection is enough to make business owners choose the LLC business structure over the sole proprietorship, which requires business owners to accept unlimited personal liability.
LLCs also give business owners the unique option to file taxes as a sole proprietor, a corporation, or a partnership. For instance, you can run a “single member LLC” and be taxed as a sole proprietor, or you can elect to file business taxes as a corporation. Similarly, if the business has multiple owners, you can elect to file as a partnership or as a corporation.
The flexibility to choose the best option when filing your business’s taxes can help you retain the ease and legal benefits of the LLC, with the tax benefits of any business structure that best meets your financial needs.
Disadvantages of an LLC
While the LLC can be the right choice for many business owners, the business structure does have its downsides.
For example, a business that operates as an LLC can have a shorter life expectancy. When one member decides to leave an LLC, the company often has no choice but to dissolve, because membership interest is generally not freely transferable between members.
This eventuality presents a significant challenge for the remaining owners, as they are responsible for finishing up remaining business obligations, paying off debts, and dividing assets and profits among themselves. The remaining members then have the choice of starting a new LLC or leaving it behind altogether.
One way to remove this risk is by writing an alternative plan into the operating agreement, including how a member can exit the business without this sort of abrupt ending.
How to form a limited liability company
When you’re ready to adopt this business structure, here are the steps you need to take to form an LLC.
Step 1: Choose a business name
When you register the business with the state, the business name is also automatically registered, so make sure you register a name you’re happy with. When selecting a business name for your LLC, be sure that it is a unique name in your state, that it indicates its standing as an LLC (e.g. “Joe’s Coffee, LLC”), and that it doesn’t include any words that are restricted by your specific state (the term “insurance” is restricted in certain states, for example).
Step 2: File articles of organization
As a part of forming your LLC, you will file the “articles of organization,” a simple document that includes your business name, the names of its members, and the address of the business. Where you file this document varies by state, so consult your state government’s website for more information on where to file and pay any associated fees.
Step 3: Draft the operating agreement
If you are planning to form a multi-member LLC then it’s advisable to create an operating agreement. This document is not required by most states, but it makes the rules, regulations, and structure of finances clear to all involved parties. Items to include in the agreement are: percentage of interest, allocation of profits and losses, members’ rights and responsibilities, and the acceptable procedure for leaving the business.
Step 4: Acquire licenses and permits
The regulations for licenses and permits vary by state, locality, and industry. Check with your state and make obtain the proper business licenses and permits for your newly registered LLC.
Step 5: Obtain an Employer Insurance Number
An Employer Insurance Number (EIN) is used to track your business for tax purposes. Even if you do not have any employees, as long as you are filing as a corporation or partnership, you are required to have an EIN. You can obtain an EIN via the IRS website once your business is fully registered.
Step 6: Make the announcement
Finally, some states require newly registered LLCs to announce their formation in the local newspapers. Check with your state’s business filing office and your county clerk to determine if you need to run an announcement ad in a specific publication; not all publications are appropriate.