You have a number of different options when it comes to structuring your business. You might want to consider a limited liability company, or an LLC, because in some ways you get the best of both worlds:
- You get the benefit of personal liability protection, as you would with a corporation.
- You keep things simple with a business that’s easier to run, similar to a partnership or sole proprietorship (for example, you aren’t required to file corporate taxes).
Who can form an LLC?
The good news is that just about anyone can start an LLC. You don’t need a huge company, lots of employees, or anyone but yourself (except in Massachusetts, where you need to have two owners).
The owners of an LLC are called “members” and there are no special qualifications required, but in most states, you can’t form one if you are in certain licensed professions, such as an attorney or a medical doctor. In that case, you can form a professional corporation, or PC.
You can have as many members (owners) as you want in your LLC, but most LLCs keep the ownership small (no more than five members), since you do need to work closely with each other and have a shared vision. Be sure the members are people you trust and can work with. A good LLC is like a marriage in that way.
How to form an LLC
- Create a business plan. Once you’ve decided that an LLC is a good fit for your business, you should start by creating a business plan (although it is not required), so that you have a roadmap for what you’re going to do and how you’re going to do it.
- Name your business. Next, you need to do a search within your state to make sure no one else is using the same business name you have chosen (it’s confusing for everyone if there are two Bob’s Plumbing companies). Your secretary of state’s office will do the search and give you clearance if the name is available.
- Choose a registered agent. This is a person who will accept legal service and notifications on behalf of your LLC. It doesn’t have to be you or any other member; it just has to be someone within the state willing to accept those documents (there are registered agent companies you can contract with). Choosing someone else frees you up from having to be available for service.
- File your articles of organization. To make your LLC official, you’ll need to fill out an articles of organization form from your state that includes the LLC name, registered agent, names of members, and other basic information. You’ll file this with the secretary of state, often in the corporation division. There will be a filing fee that is usually under $100.
- Write an operating agreement. Use your business plan to create an operating agreement for your LLC. This does not have to be filed with the state, but it is an essential document you will rely on. An operating agreement includes identifying information about the company, a statement of the company’s intent, the business purpose of the LLC, the term of the LLC, how it chooses to be taxed, and how new members will be admitted, as well as other general operating provisions.
- Comply with local requirements. Be sure to complete any local licensing or registration requirements for businesses in your county or city. In certain locations, you may be required to file a DBA (or “doing business as”) document that identifies the individuals behind the LLC.
Managing your LLC
Now that you’ve set up your LLC, you can get down to the business of actually running it—and that means working with the other members successfully. There are two different ways you can choose to manage your LLC:
- Member management. In this method, the members are the ones actually doing the hands-on management. All the members vote on decisions and work in the business. This means you’ll need to have a clear business structure and defined roles. Your operating agreement should set out what each member’s responsibilities are and how the business will actually run.
- Manager management. In this method, the members select one or more members or bring in an outside person (such as a CEO or COO) who will take on the responsibility for day-to-day management of the LLC. The members who are not in managing roles don’t actually control how the business runs. Instead, they function more like investors who have put up their money and are waiting to see their profits. Only those people who are named as managers are able to vote on management decisions and do business on behalf of the LLC.
The main reason most people decide to form their small business as an LLC is to protect themselves from liability. An LLC shields you from liability for the company’s business debts and claims. So, if your business gets behind on a business line of credit, the bank can sue only your company and reach only your company’s assets. It can’t sue you personally or try to take your house or your car or anything you own in your own name.
You are on the hook, though, for any money you’ve invested in the LLC—because those funds belong to the LLC, but your liability is limited after that point.
The exceptions to the rule
LLC personal liability protection can be a great shield, but it doesn’t protect you from everything. Personal liability exceptions to LLC liability protection are the same as those faced by corporations.
You can still be personally liable as an LLC member if you:
- Personally injure another person directly
- Give a personal guarantee for a loan or debt for your LLC and the LLC then defaults on it
- Do not pay the taxes your LLC withholds from your employees’ pay
- Cause harm to the LLC or another person by intentionally doing something fraudulent or illegal
The biggest pitfall that will expose you to liability is failing to keep the LLC and your personal affairs separate. You have to take your own LLC seriously if you want other people to.
If you’re just using your LLC bank account as your own personal checking account or you don’t pay your business bills from that account, then it’s going to be clear that the LLC truly is not a separate entity. In your own mind, you need to think of it as separate and act accordingly.
How to separate your LLC from your life
In your mind, work is just part of your life, so it can be hard to keep your LLC separate and keep a clear line between your personal life and your company. It’s essential you do so, though, if you want to enjoy the limited liability protections.
To protect your LLC status:
- Have an operating agreement. Set out your business details in writing, so you and the other members are clear on your mission and your procedures and practices.
- Bank separately. Use a business bank account for your LLC, deposit all business checks there, and pay all business expenses out of it.
- Fund your business. You and the other members should invest enough money so that your LLC can run itself, pay its expenses, and be financially independent.
- Be legit. Get a federal employer identification number (EIN) for the LLC and keep a clear account of your business’s finances, so there can be no question that it is a separate entity.
- Be honest. Don’t misrepresent the state of your company’s finances to creditors or vendors.
Business insurance can be an added layer of liability protection for you from your LLC. An insurance policy will cover liability that might affect you personally.
For example, if you own a hair salon and accidentally graze a client’s face with your scissors, you could be personally liable, since it is a personal act that caused harm to another person. But a good business insurance policy will cover this mistake and help protect your personal assets.
Business insurance also protects the LLC itself from lawsuits and claims. For example, if you own a landscaping business and one of your mowers accidentally hits a client’s marble stone lion and damages it, your business insurance will pay the claim. However, business insurance only covers liability for negligence—it doesn’t cover unpaid business debts.
While an LLC offers some tax advantages, you’ll still be paying taxes, and it’s important to do so on time and accurately. The LLC itself must file IRS Form 1065 yearly. This is the same form used by partnerships and it reports each member’s share of the profits and losses from the LLC.
Learn more about how to file your LLC taxes in this article.
Although it must file a form each year, your LLC enjoys pass-through tax liability. This means the LLC itself does not pay taxes. Instead, the LLC members are responsible for paying taxes, and each member pays their own share. So, if you have two members who are equal owners, each will be responsible for reporting half of the profits or losses for the LLC on their own personal tax returns. You’ll have to make quarterly tax payments so long as you own the LLC, so be sure to stay on top of that.
Closing your LLC
Should you reach the point where you’re ready to close the doors to your business, there are some steps you’ll need to take to officially end your LLC. In most states, unless your operating agreement says otherwise, when one member wants to leave the LLC, it must be dissolved. If more than one member wants to leave, you have the same result. And if you’re the sole member, it’s up to you.
If you want to avoid the problem of having to close down because one member wants out, you can include buy-sell guidelines in your operating agreement that set out what will happen if one member wants out, decides to retire, dies, or becomes disabled.
To close down the LLC, you need to pay off remaining business debt, fulfill any remaining obligations (such as shipping orders), and decide if you will sell business assets (such as real estate or equipment) or divide them among the members. You must pay all tax responsibilities and notify all of your creditors that you will be closing.
You must file to dissolve the LLC with your state as well. Then the members must divide any remaining assets or profits among themselves, in proportion to their ownership amounts. One or more members can decide to open a new LLC if they choose, and this may be the thing that makes the most sense if you’ve been forced to close down due to one member leaving.
Is forming an LLC right for me?
Only you can answer that question, after taking into consideration your business goals and financial needs—including what types of liability issues could arise specific to the services you provide.
Whether you’re a solopreneur or building a fast-growing startup, forming an LLC can be an effective way to combine business liability protection with a flexible form of organization that’s easier to manage.
When you’re ready to form an LLC, you’ll also want to decide whether to handle the filing and paperwork on your own, or to ask a provider like LegalZoom to help.