One of the biggest misconceptions about owning a franchise business is that you will automatically receive personal asset protection. Just because the parent company is registered as a limited liability company (LLC) or corporation does not mean that each franchisee receives this same business structure!
The LLC is a popular option for all sorts of businesses looking for asset protection, and it has a handful of other major advantages as well. Of course, forming an LLC isn’t the only option for your franchise business, so our mission is to help you decide if it’s the best choice for you.
There are many different factors to consider when you’re forming a business entity for your franchise, so let’s dive into the details of the LLC to figure out if you should form one.
What Is an LLC?
First off, let’s quickly outline what an LLC is. LLCs are formal legal entities that are typically taxed similarly to sole proprietorships and general partnerships, in that the owners include any company profits or losses into their personal returns — the LLC itself does not owe income taxes. An LLC may also elect to be taxed like a corporation, although this is not a very common option.
There are similarities to corporations too, especially when it comes to financial responsibilities. In an LLC, the owners or members are not usually personally accountable for the financial status of the business. This means that if someone sues your LLC, your personal assets are not at risk.
Why Starting an LLC for a Franchise Is Important
The top reason to form an LLC for a franchise business is to gain access to the personal asset protection provided by this business structure. Whether you operate a restaurant in a popular fast-food chain or a retail convenience store with a wide variety of products, you need the limited liability protections that an LLC can provide.
With a franchise, it’s important to form an LLC before you ever sign your franchise agreement. This is because it’s vital to have personal asset protection before you start transacting business. If you don’t, a creditor could claim that they did business with your company when it was a sole proprietorship or general partnership, and the courts would likely grant them access to your personal assets.
As an example, let’s say that a customer slips on a wet spot on your floor, falls over, and injures themselves. If you operate your franchise as a sole proprietorship or general partnership, your personal assets — like your house, car, personal bank accounts, etc. — would be at risk if that customer decides to sue your business.
On the other hand, if you form an LLC for your franchise before you begin conducting business, and you operate and maintain that LLC in a compliant fashion, the scope of your customer’s lawsuit will be limited to your business assets. In other words, your personal assets will be protected by the business structure you’ve chosen.
This is just the tip of the iceberg when it comes to the advantages of the LLC for a franchisee. Another important aspect is taxation. The LLC actually provides its owners with a selection of options regarding how they want the business to be taxed, which can save you a considerable amount of money compared to simply operating as an informal business entity.
Your franchise LLC can be taxed as a sole proprietorship (for single-member LLCs) or general partnership (for multi-member LLCs), which is the default option. With this tax structure, your franchise business itself does not pay taxes, but rather the profits are passed through the business entity and your owners pay taxes on that money when they file their own personal taxes.
You can also choose for your franchise to be taxed as a C corporation, although this option isn’t very popular because it subjects your business to what’s known as double taxation — meaning that your profits are taxed first on the corporate level and again on the personal level when they’re distributed to your owners.
The other option is S corporation taxation. There are quite a few limitations to electing S corp taxation, but most franchise businesses have no trouble meeting these requirements — your business cannot have more than 100 owners, they all must be either residents or citizens of the United States, etc.
S corp taxation can help your franchise save money by reducing your self-employment tax burden. Instead of paying self-employment taxes (a 15.3% tax that includes the employer and employee portions of Medicare and Social Security) on all of your business income, you can pay yourself and your co-owners a reasonable salary for your roles and only pay self-employment tax on that portion of your income, while you can reinvest the rest of it into your business without paying this tax.
Compared to operating a sole proprietorship or general partnership franchise business, the S corp taxation model can save you quite a bit of cash that you can use to make improvements to your business, rather than writing a big check to Uncle Sam.
Finally, an LLC structure can enhance the credibility of your franchise business venture. Informal business entities don’t have exclusive assumed business names and typically operate under the personal name(s) of their owner(s). For instance, if your name is Johnny Smith and you operate a franchise sole proprietorship, your company’s name is also “Johnny Smith.”
Of course, this issue is much less important with franchises, because the public perception of a franchise is typically more in line with the parent company than the individual franchisee. Still, it’s undeniable that your vendors and business clients will take you more seriously if you form a formal business structure.
How to Start a Franchise LLC
The formation process for LLCs varies depending on which state you’re forming one in, but in general, the process has some universal steps that need to be taken no matter what state your business is located in. If you want a comprehensive overview of all the steps required to form an LLC, check out our complete guide on the topic. The basic steps in the LLC formation process in any state are as follows:
The 3 Best LLC Services
When forming an LLC for your business, you generally have three main options. You can form your own LLC using the DIY method, you can hire an attorney, or you can hire an online business formation service.
The DIY route can require quite a bit of effort, and if you’re not comfortable with the process, it can cause some undue stress. As for hiring a lawyer, many startups can’t afford to spend the thousands of dollars it can cost for an attorney to form your business entity.
This leads us to the third option, hiring an online LLC service. There are dozens of reputable companies offering this service these days, and they can all save you a tremendous amount of money compared to an attorney. In addition, while these companies may not have as much expertise as an attorney does, they still provide a considerable amount of peace of mind compared to the DIY route.
If you want to take a look at the top options for online business formation services, head on over to our guide to the seven best LLC formation services available. In addition, we’ll briefly break down our top three options on this page. These are, in our opinion, the best options for business formation service:
- ZenBusiness ($39): ZenBusiness truly has it all. They provide complete LLC formation service along with a full year of registered agent service for one incredibly low rate, and they also have stellar customer feedback. It’s hard to go wrong with an offer like this.
- Northwest Registered Agent ($79): Northwest is a bit more expensive than ZenBusiness, but their industry-best registered agent service (included at no extra charge) includes local scanning of every document they receive on your behalf. They also have the best customer support available for LLC formation services. If you’re looking for more of a premium service, Northwest is an excellent choice.
- Incfile (FREE): Incfile has a business formation package that is free of charge, as long as you pay your own state fee. That’s obviously an enticing offer, especially when you consider that they also provide a year of registered agent. Throw in their strong customer feedback, and Incfile is an excellent choice for LLC formations.
Additional Resources for Starting a Franchise
- Score.org Franchising Resources: Score.org provides franchise business owners with a wealth of information, from webinars to guides, blogs, virtual classes, and more. If you’re looking for advice on franchise agreements, financial considerations, or any other aspect of franchise ownership, you’ll likely find it with Score.org.
- Free Management Library: Free Management Library offers resources for entrepreneurs in a wide variety of business types, and they have a great library of tools for franchising as well. They have plenty of information about preparing to become a franchise owner, how to choose the right franchise, funding your franchise, and more.
- American Association of Franchisees & Dealers: The mission of the AAFD is to “educate the public regarding fair franchise practices, quality franchise opportunities, and to expose the unethical practices that have too long existed in the franchising community.” The AAFD’s website has information on fairness initiatives, buying a franchise, and much more.
- Franchising.com: Franchising.com markets themselves as “your complete guide to buying a franchise opportunity,” and we’re not about to argue! Their site has a ton of info for franchise business owners, with sections on news and opportunities, and information about conferences and webinars.