The Pros and Cons of Creating an LLC
Are you considering starting a new limited liability company, but you’re not sure if it’s the right decision?
There are quite a few advantages to forming an LLC, but there are some disadvantages as well. Depending on your situation, creating an LLC could be an overwhelmingly smart move, or it could be a poor choice. But how do you know if the pros outweigh the cons?
In this guide, we’ll discuss the major advantages and disadvantages of forming a limited liability company. When you’ve finished reading, we’re confident that you’ll know whether it’s a good idea or not for you to create your own LLC.
What Is an LLC?
A limited liability company is a business structure that fills in the middle ground between the more casual approach of a sole proprietorship or general partnership, and the formalities of a corporation. Corporations have much more complex compliance requirements, whereas sole proprietorships and partnerships aren’t even considered to be separate legal entities from their owners.
So what are the defining characteristics of an LLC that make this business type a better (or worse!) option than those other entities? Let’s find out!
Pros of Creating an LLC
1) Personal Asset Protection
The main benefit of a limited liability company is the fact that it provides personal asset protection. This means that if your business is sued, your creditors cannot pursue your personal assets like your house, cars, and personal bank accounts.
Instead, they can only go after your business assets. In this way, your liability is limited, hence the name “limited liability company.” If you own a sole proprietorship or general partnership, creditors can pursue whatever assets they want.
2) Simple Formation and Maintenance
Compared to the complex rules and regulations for corporations, the limited liability company is relatively simple to form, and the ongoing compliance requirements aren’t all that complicated either.
The paperwork required for the formation process is mostly just the basics, and most states have templates available on their websites. As for the maintenance requirements, many states do require annual reports, but they’re mostly painless and just a way to update the state regarding any important changes to your company’s contact info.
3) Pass-Through Taxation Model
While LLC owners do have the option to have their businesses taxed like a C corporation or S corporation, the vast majority of LLCs choose to be taxed like a partnership.
With this form of taxation, the profits “pass through” the business entity and are claimed on the owners’ personal tax returns ― there is no business tax return at all. This helps LLCs avoid the double taxation that usually befalls corporations, where profits are first taxed on the corporate level, and then again on the individual level.
4) Flexible Management
One major contributor to the popularity of limited liability companies is the fact that they’re so flexible regarding ownership and management.
You can operate an LLC as a single-member business, or you can have as many members as you want. This flexibility makes it easy for an LLC to grow aggressively without having to alter its business structure, unlike for example limited liability partnerships that need to have multiple owners, or S corporations which cannot exceed 100 owners.
In addition, LLCs can choose to be member-managed or manager-managed, which means that you can either have your members handle the managerial aspects, or you can hire a separate manager who is not an LLC member to take care of the day-to-day management.
5) Flexible Payouts
The limited liability company business structure allows you to pay your members however you see fit. If you want to divide your profits between all members equally, feel free. If you would rather do an uneven split that sees more involved members receive a higher share than some passive members, you can do that too.
Cons of Creating an LLC
1) Self-Employment Taxes
The government does not consider limited liability company members to be employees of that LLC, but rather they are considered to be self-employed.
This means that each member will need to pay self-employment taxes on their share of LLC profits. Self-employment taxes include both the employee and employer shares of Medicaid and social security, which comes to a rate of 15.3%, which is in addition to your income taxes.
2) Formation and Maintenance Fees
While corporations usually have to pay higher rates in the formation phase, and also when it comes to ongoing compliance, limited liability companies still have considerably higher expenses than sole proprietorships or general partnerships.
Every state charges some sort of formation fee, which can range from less than $50 all the way up to several hundred dollars. Similarly, most states also have annual report fees which also vary widely depending on which state you’re operating in.
3) Paperwork and Record-Keeping
Continuing along those lines, limited liability companies have more documentation requirements than sole proprietorships or partnerships.
The paperwork and record-keeping requirements of an LLC are still not on the level of a corporation, but considering that there is no formal formation process for sole proprietorships or general partnerships ― and these business structures are also not required to keep business and personal assets separate ― LLCs definitely are more of a hassle in this area.
4) Can Be Uninviting to Investors
Limited liability companies certainly attract more investments and venture capital than sole proprietorships or general partnerships, but they’re still nowhere near the level of corporations in this regard.
This is due to the fact that LLCs cannot issue stock, so the only way to attract investors is to sell membership shares in exchange for investments, which just isn’t nearly as common as investing in corporations is.
Should I Hire Someone to Help Form My LLC?
If you’re not thrilled about the idea of forming your own limited liability company, there are other options. Of course, if you hire someone to help form your LLC, you will decrease the amount of paperwork and hassle on your plate, while increasing the amount of money your formation will cost, so it’s up to you to determine if it’s worth it or not.
Some entrepreneurs like to hire a lawyer or accountant to form their LLCs, which is a reliable option but also one that is very expensive in most cases. Instead, we like to recommend the usage of online LLC formation services that can professionally form your new business while also saving you a significant amount of money compared to paying an attorney’s fees.
If this is an option that you’re interested in, we would recommend checking out one of these business service providers:
- IncFile – $49: Their low price tag is always appealing, and IncFile also includes a year of registered agent service with any LLC formation package. When you consider that they also receive overwhelmingly positive customer feedback, you can see why IncFile is usually our top choice for formation service.
- Northwest Registered Agent – $79: Northwest’s prices aren’t quite as impressive as IncFile’s, but their personalized one-on-one customer support is definitely an advantage. They also include a full year of registered agent service, and they’re the only major service provider that locally scans every document they receive as your agent (most competitors only scan government docs).
- LegalZoom – $149: Their high prices are a serious disadvantage, but LegalZoom has some advantages of their own, like their massive customer volume and unrivaled brand power. Throw in their 100% satisfaction guarantee, and their popularity makes some sense depending on your priorities.
As you can see, there are plenty of pros to creating a limited liability company, but there are some significant cons as well. Depending on the size of your company, your state of formation, and the nature of your business, forming an LLC may or may not be in your best interests.
To recap, the advantages of an LLC include personal asset protection, simple formation and maintenance, pass-through taxation, flexible management, and flexible payouts. The disadvantages include self-employment taxes, formation and maintenance fees, paperwork and record-keeping, and the difficulty of attracting investors.
Whether you choose to form an LLC or not, we wish you the best of luck!