As a startup, one of the earliest (and most important) questions you’ll be faced with is when it’s time to move forward from being just a sole proprietor, to a formal business structure, such as an LLC.
A limited liability company (LLC) is a business entity that provides enhanced liability protection for the business owner, and the tax benefit of a partnership. Your LLC is created and governed by your specific state’s law, and it can have one owner or multiple owners.
LLC’s have many advantages over other business formations: Unlike corporations, LLCs don’t have annual-meeting and record keeping requirements, and LLC’s can elect how they are taxed (if as a partnership or an SCorp, business profits and losses “pass through” to each owner’s individual tax return).
Above all, there is one specific reason why an LLC is the most popular business entity for startups: an LLC separates your personal assets from your business assets.
The driving factors behind deciding on a business formation revolve entirely around liability and taxes (get started with your local accountant to discuss tax considerations). Business structures such an LLC are popular for many reasons, mainly because they separate your personal assets from your business assets. If you have a DBA instead, there isn’t any separation. That means if you’re sued for anything involving your business, a court could allocate your personal assets to pay damages.
For example, say you are a florist and set up a booth one afternoon at your local farmer’s market. It’s a great success, and you have a flood of customers. Things are going swimmingly, until all of the sudden, one customer trips over something in your booth, and twists her ankle. She ends up going to the doctor and brings claims against you to recoup her medical bills, saying that you created an unsafe environment. You obviously did nothing intentionally to injure her, so wouldn’t your DBA and liability insurance protect your business?
Maybe, but it will be entirely dependent upon the terms of your insurance policy. And keep in mind, an insurance company is a business first and foremost. At the end of the day, it’s their job to give away as little money as possible. So, if we think about the worst case example and your insurance does not cover this customer’s claims, and you only have a DBA in place, your car or your house could be used to help pay damages.
One of the most common questions I get asked is if you need a lawyer to form your LLC, or if you can do it yourself. And my answer may surprise you.
As soon as possible; preferably, before you begin bringing in any income through your business endeavors.
There are four main steps to sufficiently forming your LLC: filing your articles of organization with your state; getting your EIN number, opening your business bank account, and drafting an operating agreement. While of course, it’s always best to do things right from the start, you don’t technically need a lawyer for steps 1-3. And in order to have a legitimate business, you cannot afford to overlook any of these three steps.
LLC’s are formed when you file the proper paperwork with your state- typically called the “Articles of Organization”. The form is simple enough, and if you know the answers to certain questions, you don’t need a lawyer to help you do it. For example, how will your LLC be managed? Will it be perpetual, or have an end date? Do you need a series LLC? Who is your registered agent?
An operating agreement is basically the “contract” that will govern your LLC. They’re actually not required in every state, but most banks will require that you have one in order to open a business bank account. The operating agreement will set forth how distributions and losses are shared, how the LLC is managed and taxed, how members can sell or replace shares, etc. Are you unsure on if you’re going to add new members to your business someday? Your operating agreement, if written correctly, will cover all of this. How can your LLC be dissolved, restructured, or “wound up”? The language that you use in your operating agreement is imperative: if your LLC is involved in litigation, it will be considered an enforceable contract by the court.
There’s another reason why an operating agreement is imperative- it will protect you from something called “piercing the corporate veil”, which single-member businesses in particular are highly susceptible to. You can find more information about PCV in the “business bank account chapter” . Your operating agreement should never be a simple, flimsy document. Like I said, not only is it a contract, but its the contract that governs your business. Choosing to have a lawyer draft this agreement can be the sole differentiating factor between running your business the way you actually intend, or letting your business be dictated by an erroneous document.
I’ve converted the operating agreement I wrote into a template, which is available for purchase here.
This is a great question, and one that I get all the time. It’s important to keep in mind what the purpose of an LLC is: to create a shield of protection between your personal assets and your business assets. Basically, an LLC creates a bubble around the LLC’s assets, liability can’t go in or out.
So, if you have multiple businesses and they share one LLC, they would share that LLC’s liability. It doesn’t matter how many DBAs or “Side hustles” you may have; they are all housed under the same bubble of liability. Now, when you are just starting out with those side hustles and are just testing the market to see what are viable business decisions, it is really a moot point to starting creating multiple LLCs. Honestly, until you know that those businesses are solid enough to last for awhile, there is no need to have multiple LLCs, because you won’t have enough assets to require liability protection.
However, when you have multiple businesses that are all solid, you’ll want to separate that liability for the same reason that you create an LLC in the first place. Or, something called a series LLC may be the best choice for you- check with an attorney in your jurisdiction to see if you would be a good candidate.
If you are operating your business with a name other than your registered LLC name, you may want to file for a DBA. A great example of this is my own business, the Creative Law Shop®. The Creative Law Shop® is actually Paige Hulse, LLC, d/b/a “The Creative Law Shop”. I chose to do this for many reasons, one of which being that I wanted to allow for flexibility for future growth.
1. Limited Liability Protection.
As I mentioned, if you are regularly selling a good or service, you work with or sell to clients in person, or you want your business to carry separate liability credit cards, and so from your personal assets, it’s time to file an LLC.
2. You want to be taxed as a flow through entity.
Taxes make all of our heads spin, and I want you to find a good, local accountant to help
you with that side of your business. In essence, if you make a certain amount of money per year (about 40K annually), you can file an S-Corp, which allows you to take a paycheck from your business, and have taxes withheld throughout the year. Basically, an LLC will provide you with options when it comes to taxes, and because small business incomes tend to fluctuate so much, that flexibility can be crucial.
3. You’d like to hire an employee or independent contractor, or you have a partner.
If you have any other individuals associated with your company, whether they are hires or partners, I can’t stress the importance of an LLC enough. Hiring and partnerships are best handled by the operating agreement, which is the contract that governs the LLC. The operating agreement will lay out the governance of the LLC, such as voting, allocations of profits, losses, compensations, who is authorized to act on behalf of the company. By defining these types of decisions in the operating agreement, you cut down on the chance of misunderstandings, which we all know happen all too often. Also, in the chance that one of these relationships go south, the LLC formation will again protect your personal assets from the actions of the business.
In conclusion, unless you are brand, brand new to your business and you don’t know if it will be around next month, I really don’t know of any circumstances in which you wouldn’t need an LLC. It’s never too early to start protecting your business, and an LLC is the #1 way to do so.