The business structure that is chosen has a direct impact on mundane activities as well as actions pivotal to business operations. Entrepreneurs have the option of choosing one of the following business structures, viz. sole proprietorship, partnership, S-corp, C-corp, and limited liability company (LLC). The advantages and disadvantages of establishing a limited liability company have been discussed in the following paragraphs.
Defining Limited Liability Company
LLC is a fairly new business structure that combines the limited liability feature of a corporation with the single taxation (pass-through taxation) feature of a partnership or a sole proprietorship. While shareholders are the owners of a corporation, a limited liability company is owned by members. In the absence of an operating agreement, the company is subject to the 'default rules' of the state in which it is organized. For instance, default state laws may ensure that all members, viz. individuals, corporations, other LLCs, or foreign entities have equal ownership interests. An operating agreement can override this unfavorable clause and specify ownership interests in no uncertain terms.
A limited liability company can choose to be taxed as a corporation, a partnership, or a sole proprietorship. This is a big advantage since the benefit of pass-through taxation can be availed by an LLC. However, if it chooses to be taxed as a C-Corp double taxation is inevitable. One must bear in mind that an S-Corp can jump through a few hoops and avoid double taxation by skipping the intermediate step of paying dividends and passing earnings directly to shareholders. However, 16 states tax LLCs more favorably than S-Corps. Again, to qualify for the S-Corp status, the number of shareholders cannot be more than 100 while there is no upper limit on the number of people who can own an LLC.
Limited Personal Liability
The members of the LLC are not personally liable for business debts. In other words, only the assets of the LLC can be used to pay off business debts. However, members may become liable for business debts by providing personal guarantees, signing contracts in their name, or due to shoddy book-keeping.
The continuity of a limited liability company is ensured by having an operating agreement in place, since default laws allow for the dissolution of an LLC even if one member wants to quit. The operating agreement states the course of action that should be adopted if one or more members become disabled, die, or desire to sell their interest in the LLC.
An LLC enjoys the limited liability benefits of a corporation without having to meet other administrative requirements such as holding annual meetings, recording minutes of the meeting, electing board of directors/officers, filing annual reports, and so on.
Franchise or Margin Tax
Most states impose a franchise tax or a margin tax on LLCs since the latter enjoys a limited liability status. Depending on the state in which the LLC is organized, the tax may be a flat fee or may be calculated on the basis of the revenue that is generated, the profits earned by the enterprise, or the amount of capital invested. Sometimes, the number of members may also be the deciding factor for calculating the franchise or margin tax.
An LLC may find it difficult to raise capital since investors prefer funding companies that sell stock. The capital requirements of the LLC can be met by selling ownership interest or by taking on debt. Creditors generally require members to provide a personal guarantee for the repayment of the debt obligation. This, in turn, negates the advantages of limited personal liability.
The above article would have given one a clear picture about the advantages and the pitfalls of organizing a business as an LLC. The advantages and disadvantages of a limited liability company should always be examined in tandem with the benefits and the pitfalls of an S-Corp, a sole proprietorship, or a partnership for a better understanding of the repercussions of establishing the same.