The term 'LLC' stands for Limited Liability Company and indicates that this partnership business has two types of partners in it. It is a sort of partnership, in which general partners who, in most instances, look after the management of the company, are held liable for LLC's business debts. On the other hand, LLC's limited partners or members enjoy liability protection as well as favorable tax benefits.
The 'Pop-and-Mom' businesses, which are most familiar to us, are nothing but, sole proprietorship businesses. In case of sole proprietorship, the law does not make any distinction between the assets of the business and owner's private property such as house or a car. If the owner loses a lawsuit, filed by a customer over some business related damages, he may lose his business as well as all his assets while paying for them.
One of the advantages of LLCs over sole proprietorship is that of limited liability enjoyed by its limited members. A lawsuit, claiming damages because of business transactions, cannot be filed against the limited members, unless they are part of the management. The customer can sue the LLC and recover his damages only from the assets of the LLC.
Creating an LLC
How to form an LLC? The investors, or would be owners, of an LLC are required to file relevant forms with a state's secretary. At the time of setting up an LLC, its partners have to include information such as, the latest date at which they are going to dissolve LLC. This data also states how many managers (one or many) or members, that are party to the LLC, are going to manage it.
The popularity of an LLC is due to the fact that it can be formed by members or investor, and not by shareholders. These people, by mutual understanding, create an operating agreement to run an LLC, which is more flexible than guidelines imposed on a corporation. High cost of setting up an LLC, due to business or franchise tax and special fees levied by the states in which it is created, is one of its disadvantage.
Benefits of LLC
The rules relating to formation of an LLC vary according to states, and a few allow an individual to form an LLC. The following are the LLC advantages:
- By law, an LLC absolves its members from assuming personal liability for any loss incurred during the business transactions.
- As the guidelines of a corporation are not imposed on an LLC, its members are free to formulate their own contract and decide the flexibility in management, their responsibilities and duties.
- The law supporting the LLC imparts greater flexibility to the members in dividing income among them.
- The law authorizes "S" corporations to issue only one type of stocks. On the other hand, an LLC is permitted to have various types of interest, which is one of its advantages over "S" corp.
- A corporation, or another LLC, is permitted to be the general partner of an LLC and is required, by the law, to assume the liability. The members who wants to cash their investment find this attractive, and become limited partners in an LLC to earn liability-free profit.
- The general partner of an LLC provides expertise and, most of the time, handles the management of an LLC.
- When it comes to tax, it must be noted that these entities are not levied with tax. Profit and loss made by them is passed on to its members. Each member is expected to pay tax on the income gained, by investing in an LLC, when he files his tax returns.
- Limited (liability) members of an LLC can leave, when they see fit to do so, or be replaced according to its rules and regulations. An LLC is not dissolved because of their leaving, and continues to trade which is one of the advantages over corporation.
All these plus points are due to the fact that the characteristics of both, a corporation and a partnership are clubbed together to form this legal entity. For the convenience of the investors, who are ready to take financial risks and can accept losses as well as profits in their strides, but, not the liability of a partnership, being a member of an LLC is an option.
The fact that LLC members can withdraw their capital any time they want, is clearly a disadvantage from the point of view of LLC's smooth functioning and existence. One should weigh all the advantages and disadvantages of a limited liability company before considering investing in it.