Limited liability companies (LLCs) are a popular choice for new businesses for several reasons, but they’re just one option when forming a business.
In this guide, we'll show you what forming an LLC looks like and all the tips, tricks, and things to consider before doing so.
Select your state to form an LLC on your own. If you'd rather hire a professional, use one of the recommended best LLC services.
What is an LLC?
Starting a business is an exciting prospect. If you’ve talked about forming a business with friends or family, then maybe you’ve heard the following advice: “You should form an LLC!” But what does that mean?
Below we’ll cover everything you need to know about LLCs. By the end, you’ll have a clearer idea of whether or not an LLC is right for you.
What It Is:
The LLC is a formal business entity type that blends elements of a corporation with components of a sole proprietorship or general partnership.
For example, an LLC has corporate personhood, just like a corporation does: the LLC can buy property, have a bank account, hire employees, and more. More importantly, the LLC provides personal asset protection. If your business falls into debt or legal trouble, your personal belongings cannot be taken as compensation — only the assets of the LLC itself are available to your creditors.
The owners of an LLC are commonly called “members.” Each member may or may not have the same percentage of ownership in the business. In some cases, an LLC may be owned by a single member. Because an LLC combines personal asset protection with the flexibility of having either one or multiple business owners, it is a popular choice for new businesses.
What It Isn’t:
Even though LLCs can be owned by multiple people, you can’t simply “buy in” to become an owner of the business like you can with a corporation. While corporations can sell stock, the LLC cannot raise capital by selling stocks. External investments have to come from other sources.
The LLC also is not required to file the same paperwork as a corporation. This paperwork is one of the primary reasons that businesses choose an LLC over a corporation because corporations have to maintain detailed records, including bylaws, minutes from the board of directors’ and annual shareholder meetings, stock ledgers, and the list goes on.
LLCs need to file annual reports and a few other items, but the paperwork burden is quite minimal by comparison.
How It’s Formed:
In terms of formal business entities, LLCs are arguably the easiest to form. To do so, the LLC’s organizer should file the articles of organization with the Secretary of State, as this document serves to officially establish the business.
The articles of organization usually require the following information:
- Proposed name for the LLC
- Names, addresses, and signatures of the LLC’s members
- Name and address of your registered agent
- Physical address for the business
- Management style (member-managed or manager-managed)
For practical and financial purposes, the members of a newly formed LLC should create an operating agreement, which dictates how your business functions.
While you don’t have to file this document with the Secretary of State in most states, you should still write up an agreement to prevent disputes down the line. It can include elements such as what percentage of the business profits will pass to each member, what happens if a member wants to leave the business, how to add new members, and more.
You can take several different approaches to set up your operating agreement. Ideally, you can draft your own agreement with a little legal advice from an attorney. This approach guarantees that your agreement will best fit the unique needs of your business. However, you can also use a template from an online business formation service such as ZenBusiness or Northwest Registered Agent.
In fact, if you don’t have the time to file the formation documents yourself, you can hire one of these services to do the paperwork for you. This option would allow you to focus more on advancing your business concept.
Why an LLC?
As we’ve mentioned, an LLC is relatively easy to form and maintain. The formation paperwork is minimal compared to corporations, and your list of annual compliance requirements is usually pretty short as well.
Escaping paperwork shouldn’t be your only motivation to form an LLC, however. Even though an LLC requires much more paperwork than an informal business entity, an LLC has a massive advantage over a sole proprietorship or general partnership: personal asset protection.
As a sole proprietor or general partner, your business finances and personal finances are one and the same. That’s why your car, house, and other assets can be taken as compensation if your business runs into trouble. As an LLC, though, you won’t run into that issue. If you form and maintain your LLC in compliance with state laws, only your business assets would be at risk in a lawsuit, while your personal assets are protected by the entity’s limited liability feature.
Another advantage of the LLC is that you can choose the taxation process that works best for you. The options include taxation as a corporation or as a pass-through entity. As a pass-through entity, your business will not file its own tax return — instead, you’ll just have to submit an informational report stating how much money your business earned or lost.
With this taxation model, your individual members will receive income from the LLC (how much each member gets is dictated by the operating agreement), and each member then reports that income on his or her individual tax return and pays the resulting taxes.
As a result, the total amount of money that is paid as tax for the LLC’s profits is typically lower than it would be as a corporation. The only issue is that your members will likely be required to pay self-employment tax, which is a 15.3% tax that combines the employer and employee portions of Medicare and Social Security.
If your LLC was taxed as a C corporation, the LLC would pay taxes itself as an entity, using the corporate income tax rate of 21%. With this form of taxation, your members would be subject to what’s commonly referred to as “double taxation,” because the profits are taxed once at the corporate level, then taxed again on the personal level after the company distributes the funds to the individual members. This taxation option is typically only advisable if your members are high-income individuals who can save money by avoiding high personal tax bracket rates.
Finally, you can also classify an LLC as an S corporation, which is basically a compromise between the two options we’ve discussed thus far. With S corp taxation, most elements of the pass-through model apply, with the only exception being that your owners can avoid self-employment tax due to the S corp model treating them as employees. However, there are many restrictions to S corp eligibility that make this option fairly rare.
The LLC is a great choice for a wide variety of business startups due to its combination of flexibility and personal asset protection. When it comes down to it, we think the LLC is the ideal structure for many different types of businesses.
Whether the LLC is the correct business structure for your specific company or not comes down to several important factors, including taxation, personal asset protection, company structure, and more.
Advantages of an LLC
1) Easy to form and maintain
LLCs are the easiest formal business type to create in America today, especially in comparison to a corporation.
With an LLC, the basic formation requirement is simply to prepare and file your articles of organization with your state government, whereas other entity types have more legal hoops to go through.
Similarly, LLCs do not have as many maintenance requirements. In general, an LLC needs to file an annual report and any fees required by the state, and in some states, there’s also a franchise tax payment as part of the maintenance process. In terms of ongoing compliance issues, these are fairly simple requirements.
2) Fewer formalities and paperwork
Corporations are legally required to maintain a heap of paperwork, including bylaws, minutes from shareholder and director meetings, business ledgers, and much more.
The formalities required are often considered to be a hassle, and that’s without even mentioning the incorporation process itself, which requires far more time and effort than forming an LLC.
Luckily, LLCs do not have to worry about these requirements. An LLC does need to maintain some business records, but not to the same extent. Any meetings are held at the discretion of the members, whereas corporations must have meetings for both shareholders and the board of directors.
3) Personal asset protection
As a formal business entity, an LLC has what’s commonly referred to as a “corporate veil.” The veil establishes a line between your business finances and your personal finances.
This division is extremely important.
Here’s why: If the LLC runs into debt or legal trouble, someone has to pay up, but thanks to the corporate veil, the LLC itself will pay these costs. If your company’s finances are insufficient, your personal funds and assets cannot be taken to make up the difference.
For example, let’s say that you run a bicycle repair shop. You complete a standard tune-up for a client, but the cyclist wrecks because a part you replaced came loose. The client, who broke several bones in the fall, sues for damages. Your small repair shop lacks sufficient funds to pay for the settlement.
In this situation, if you are a sole proprietor, you would be ordered to pay these expenses from your personal assets ― your car, house, and more would be at risk.
As an LLC, you would not encounter this problem. Hopefully, debts and lawsuits will be a rare occurrence in your business ventures, but when something does happen, the corporate veil will help protect you.
4) Flexible membership structures
Corporations operate under rigid structural formalities that can be a hassle to comply with. While the LLC has the freedom to choose managerial structures, corporations must comply with strict requirements, with a board of directors, appointed officers, and shareholders all filling distinct roles.
There are further restrictions on S corporations as well. Unlike an S corporation, an LLC or C corporation can have a single member, a dozen members, a hundred members — there is no restriction on the number of members an LLC or C corporation can have.
Similarly, your members can be foreign investors, not just U.S. citizens. With an S corporation, you cannot have any nonresident alien owners, and you can’t have more than 100 members either.
5) Tax flexibility
LLCs may choose to be taxed as a corporation or a pass-through entity. This flexibility is uncommon for businesses, and it allows the LLC’s members to pick the tax approach that most benefits them.
LLCs usually elect the default option, which is to be taxed as a pass-through entity. With this tax approach, the LLC itself does not pay taxes. Instead, the business income is passed through to the members of the LLC, who then report that income on their personal tax returns.
LLCs taxed as corporations work in the opposite way ― the LLC pays taxes itself. This approach requires the entity to pay the corporate income tax and is typically only preferable if the LLC’s owners are high-income individuals for whom the corporate tax rate would be lower than their individual tax brackets.
Disadvantages of an LLC
1) Trickier to raise funds through investments
LLCs are allowed to raise capital through outside investments, but corporations are far more appealing to most investors.
First off, LLCs cannot issue stock, and shares of stock from a corporation are a preferred form of investment for nearly all private investors. Furthermore, venture capitalists almost never invest in LLCs, because the pass-through entity type is highly disadvantageous for VC investors.
2) Self-employment taxes
While taxation is typically an advantage for LLCs, it’s a disadvantage in the realm of self-employment taxes.
This is because all LLC owners are considered to be self-employed individuals, which means they’re subject to the 15.3% self-employment tax rate, a rate that includes both the employer and employee portions of Medicare and Social Security. By contrast, corporation owners are not legally viewed as self-employed people and are therefore exempt from paying this tax.
3) Legalities vary from state to state
One downside of the LLC is the way each state is allowed to create its own guidelines for how they should be formed and maintained. Therefore, it can be difficult to figure out exactly what’s expected from your LLC, especially if your business operates in multiple states.
In addition, the LLC was introduced to the American business landscape fairly recently, so there can also be some inconsistency and confusion regarding how courts in different states handle lawsuits involving LLCs because there’s a lack of precedent in some states.
4) More hassle than operating an informal business
While the LLC has an advantage over corporations in this area, it still requires more time, effort, and money to form and maintain than a general partnership or sole proprietorship.
With these informal business structures, there’s no formation process, no maintenance requirements, and no fees to pay. Of course, sole proprietorships and general partnerships have some significant disadvantages (like no personal asset protection), but the LLC is certainly more of a hassle to form and operate.
Steps to Forming an LLC
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If you’ve decided that forming an LLC is the right option for your business, it’s time to start tackling the formation process. Keep in mind that the exact steps will vary depending on your state, so make sure to dig into the specifics of your state to make sure you’re completing the process correctly. In general, these are the steps you’ll need to take to form a compliant LLC in most states.
1) Name your LLC
The first step in any state is to come up with the perfect business name for your new LLC. Your LLC’s name is important because it’s your company’s best chance to make a first impression with potential customers, and you need to make an impact. Choose something memorable that also highlights the purpose of your business.
Another crucial aspect of naming your LLC is making sure the name you want is actually available and hasn’t already been claimed by another entrepreneur. Therefore, you should search your state’s business database to ensure that you can use your desired name. (It’s probably a good idea to come up with a few different options in case your first choice is taken!)
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2) Designate a registered agent
Every LLC operating in the United States must have a registered agent. This role includes receiving important document deliveries from the state (such as service of process paperwork and annual report reminders), informing you of the receipt, and forwarding the documents to your business. In short, the registered agent ensures that the state always has a reliable point of contact for every company operating within its borders.
Just about anyone can be your registered agent, as you can designate an individual or a professional registered agent service for this role. Most states don’t have any rules regarding who can serve as a registered agent, except the LLC itself cannot be its own agent. (Colorado also requires that all registered agents be at least 18 years old, but you won’t find this restriction in other states.)
3) Prepare and file your LLC formation documents
This is the most important step in your LLC formation journey. Most states refer to these documents as the Articles of Organization, although some other states use alternate names, such as the Certificate of Formation.
The information required for this filing varies by state as well, but for the most part, you’ll need to include the name of your LLC, the principal office and mailing addresses, the registered agent’s name and address, whether the LLC is managed by members or managers, and the name and address of at least one member or manager.
Again, the exact info can vary, and each state has its own processing times as well, so make sure you nail down all of the relevant details for your state before you get started.
4) Draft an operating agreement
There are only a few states that require LLCs to draft and submit an operating agreement to the state, but we think that every LLC should have one regardless of whether it’s technically required. An operating agreement is important because it outlines the details of how your business will be run, and it can help prevent ownership disputes.
Typically, the type of information you’ll want to include in your operating agreement includes details about the business structure, the business purpose, management and voting rights, capital contributions and distributions, membership changes, the dissolution process, and more.
Even if you own and operate a single-member LLC by yourself, you should create an operating agreement because it helps you separate the LLC from yourself as a person, a crucial aspect of personal asset protection.
5) Obtain an EIN
The next step is to acquire a federal tax ID number (often referred to as an EIN or employer identification number) from the Internal Revenue Service. This is similar to a Social Security number for an individual, as the EIN is a nine-digit number that’s used to identify your business for taxation purposes. An EIN can help your LLC accomplish many important tasks, including opening business bank accounts (more on this in a moment…), hiring employees, and more.
6) Set up the LLC’s financial infrastructure
Next, you’ll need to set up a business bank account and an accounting system. The business bank account is simple enough — all you need to do is bring your EIN to the bank of your choice and tell them you’d like to set up a business account. Once the account is set up, make sure to use it exclusively for your business expenses and income. Commingling your business and personal assets is a highly dangerous practice that makes your LLC susceptible to lawsuits, administrative dissolution, and more.
As for your accounting system, the easiest solution is to get accounting software like QuickBooks for your business. This allows you to keep track of all your business income and expenses in one convenient place, making tax time (and legal compliance) a breeze.
7) Acquire licenses and permits
Some states require LLCs to obtain a general business license to operate in a compliant fashion, while others do not. Whether your state requires a general license or not, it’s likely that your LLC will require at least one license or permit. There are quite a few industries that require either federal or state licensure (or both), such as agriculture, aviation, mining, firearms, broadcasting, and more.
In addition, there are many different licenses required by county and municipal governments, including liquor licenses and occupancy permits. Don’t forget to check with every government agency that has power over your business (federal, state, county, municipal) to ensure you’re complying with all relevant licensing and permitting requirements.
8) Obtain business insurance
If your business has employees, you will be legally required to acquire workers’ compensation insurance in most states. And, even if your business is located in Texas (the one state that doesn’t require workers’ comp), you should still absolutely obtain this coverage. Beyond workers’ comp, there are many industry-specific insurance policies that might be advisable depending on the nature of your business, and a general liability policy is almost always a good idea, especially for businesses with retail locations that customers visit in person.
Hiring an LLC Formation Service
Does this process sound like a hassle? Would you rather pay someone else to form your LLC while you focus on actually growing your business? Fortunately, there are plenty of reputable LLC formation services out there that can provide professional assistance for a mere fraction of a lawyer’s fees.
There are dozens of different companies that offer LLC formation services these days, and it can be difficult to discern which of them is your best option. That’s why we put together our comprehensive guide to the top-rated business formation services available online. We encourage all of our readers to check out that guide and choose the right company for your specific situation. In addition, we’ll briefly run down a couple of our favorite options here.
ZenBusiness: $39 + State Fee
We always appreciate what ZenBusiness has to offer, and they’re our top pick for LLC formation services for a reason. First off, ZenBusiness has some of the lowest price points in the industry. In addition, this company includes some valuable features like a full year of registered agent service at no additional cost.
ZenBusiness receives spectacular feedback from its clients, with 6,200+ reviews available online and nearly all of them being positive. Finally, the company also displays tremendous corporate responsibility, as it loans money to women- and minority-owned businesses and partners with Kiva.org to help lift people out of poverty.
Incfile: $0 + State Fee
Another of our favorite options is Incfile. It’s impossible to top what Incfile has to offer for pricing, as they will form your business free of charge, as long as you pay your own state fee. Like ZenBusiness, Incfile also includes a year of registered agent service with your LLC formation service for no extra charge.
Additionally, Incfile has nearly 27,000 reviews online, with positive feedback far outweighing negative feedback. We don’t think they’re quite as well-rounded as ZenBusiness, but it sure is hard to argue with Incfile’s pricing model!
When Is the Best Time to Form an LLC?
It can be difficult to tell when you should form your LLC. Every business has different priorities, and what makes sense for one entrepreneur might not make sense for you. However, in general, we think it’s always best to form your LLC before you execute your first business transaction.
If you do business before forming your LLC, those transactions will be performed by default as a sole proprietorship or general partnership. This means these transactions are not protected by the LLC’s corporate veil, which is the layer of separation the LLC provides between your business and personal assets. Even if you form an LLC later, you as a business owner will have full liability for the transactions you executed before that business formation.
Especially considering the fact that you don’t have anything to gain from delaying your LLC’s formation, we think it’s always a good idea to form your LLC as soon as you nail down your business concept and name.
How Does the LLC Compare to Other Entities?
Throughout this article, we’ve touched on the advantages and disadvantages of the LLC as compared to other types of business entities. If you want to know more about how the LLC compares to a sole proprietorship, general partnership, or corporation, we have full-length, in-depth articles available on each topic.
That said, let’s quickly summarize the similarities and differences between these business types, so you can get a firmer grasp on whether the LLC is the right entity for your company.
- LLC vs. Sole Proprietorship / General Partnership: The sole proprietorship and general partnership are essentially the exact same thing. They’re both informal business entities that don’t require a formation process; the only difference is that a sole proprietorship is a one-person business and the general partnership involves at least two people. As we’ve discussed, these business types do not provide personal asset protection, which is such a massive disadvantage that we would essentially never recommend operating a sole proprietorship or general partnership instead of an LLC.
- LLC vs. Corporation: This is where things get a bit trickier. The LLC has some concrete advantages over the corporation, including flexible taxation, flexible business structure, a simpler formation process, fewer formalities, and (usually) lower maintenance costs. That said, the corporation has some of its own advantages, like the ability to issue stock and attract venture capitalists, as well as the well-established legal precedent of the corporation. For most small businesses, the LLC is the preferable entity type, although there are plenty of exceptions.
Things to Consider Before Starting an LLC
How serious are you about your business?
This may sound like a stupid question, but hear us out. We couldn’t possibly keep track of all the times we’ve seen people form LLCs only to do nothing with them. Therefore, we think it’s at least worth asking yourself if you’re really serious about this before you go through the hassle and expense of forming your LLC. If you are ready to do business, great! But if you’ve just had a spontaneous idea that you haven’t thought through, or if you don’t know if you have the time/energy/capacity to dedicate to a serious business, you might not be ready quite yet.
Do you plan to expand to additional states?
If you’re only planning on operating your business in one state, then go right ahead and form your LLC. However, if you have plans to do business in multiple states, a corporation might be a better fit. That’s because corporations are the same in all 50 states, whereas each state has its own version of the LLC. Therefore, the legalities and structural components of a corporation will be consistent across the U.S., while the LLC has plenty of variance from state to state.
What’s your budget?
Depending on the state, forming an LLC can be expensive. While some states only charge a nominal fee to form your LLC, there are also states that charge hundreds of dollars. If you’re operating on a very tight budget, you might need to hold off on your business plans for a bit longer than you’d hoped.
Will you be seeking outside investments?
Simply put, LLCs do not attract many outside investments. They cannot sell stock, which gives corporations an insurmountable advantage, and it’s rare to hear of venture capitalists investing in an LLC (it happens, but not often at all).
The Real Cost of Forming an LLC
Another of the most common questions we hear from entrepreneurs is how much it actually costs to form an LLC. There are often additional expenses involved with the LLC formation process, other than the fee you pay the state for your formation document filing. It’s important to note that, much like each state charges its own rates for LLC formations, the additional costs can vary from state to state (and industry to industry, in some cases) as well.
Let’s quickly break down some of the other potential costs. One that isn’t usually required is a name reservation fee, which is required by law in Alabama but is optional elsewhere. In most states, a name reservation only has a nominal fee — in many, this will only cost you $10-20.
Another variable that can add expenses is whether you choose to use an LLC formation service or not, as most of these companies charge their own service fees in addition to the state’s formation fee. Similarly, whether you want a registered agent service will also affect your new LLC’s bottom line. If you opt for assistance from an attorney instead, your expenses will obviously grow.
Then, there’s the issue of initial and annual reports. Initial reports aren’t required in very many states, but they’re a highly important part of the formation process in states that do require them. As for annual reports, most states require them from LLCs, and the costs can vary widely, from as little as $10 in Colorado all the way up to $520 in Massachusetts.
Finally, even though LLCs are usually pass-through entities, there can be state-specific tax responsibilities like franchise taxes for the right to do business in the state. All told, there are quite a few associated costs for some LLCs, while others can get by with much lower expenses. It all depends on where your company is located and what line of business it’s in.
Frequently Asked Questions
How long does it take to form an LLC?
The answer to this question varies considerably based on your state of formation. There are some states that have online LLC formation portals where you can form an LLC immediately. Meanwhile, some states require you to mail in paper forms that can take a matter of weeks. Additionally, many states offer some sort of expedited service that can dramatically speed up your formation process. For more details, ask your LLC formation service or your state’s Secretary of State office.
Should I use an online LLC formation service, hire an attorney, or form my own LLC?
All three of these options have their own advantages and disadvantages, depending on your priorities. Forming your own LLC will always be the cheapest option, although it doesn’t involve any professional assistance. On the other end of the spectrum, hiring an attorney can be prohibitively expensive for many startups, although the expert advice you’ll get can make it worthwhile. Finally, an online LLC formation service splits the difference, providing professional help while charging a fraction of an attorney’s fees.
What types of bonus features can I expect if I use an LLC formation service?
This all depends on which company you choose to form your LLC, and which of its formation packages you opt for. In general, it’s common to see these companies include perks and features like registered agent service, operating agreements, annual report service, binders embossed with your company’s name, and more.
Can I form an LLC with a limited lifespan?
Yes, when you form your LLC, you will have the option to designate a perpetual lifespan or a specified dissolution date.
What is an LLC member? What is an LLC manager?
An LLC member is another term for an owner of the business. An LLC manager refers to a designated individual who handles managerial aspects of the company. It is quite common for the same person to serve in both roles.
Can I form an LLC by myself? Or do I need co-owners?
You are welcome to form a single-member LLC if you’d rather operate your company alone or a multi-member LLC if you want co-owners. You can even change your mind and add or subtract members down the line. This is one of the flexible aspects of the LLC that can be highly beneficial for a wide variety of entrepreneurs.
Do I need to hold regular meetings for my LLC?
Corporations have strict requirements to hold shareholder and board of directors’ meetings on a regular basis, and also to take detailed minutes from those meetings. LLCs are not required to hold these meetings (or, obviously, to take notes on them). That said, you are welcome to hold meetings anytime you’d like, or not at all!
What state should I form my LLC in?
This is a bit of a tough question, as different states have different pros and cons for LLC formations. For the most part, entrepreneurs tend to form LLCs in their home states, and this is typically our recommendation as well. However, there are a few states with distinct advantages that we should briefly discuss.
Delaware is a popular option for LLC formations because it doesn’t assess taxes for business transactions performed outside the state. In addition, it has low fees and taxes, as well as an exclusive court system for business matters called the Chancery Court, a feature you won’t find in any other state.
Nevada is another common choice because of its extremely low business taxes. Nevada also allows LLC owners to remain anonymous, and it won’t even report LLC ownership info to the Internal Revenue Service. If you’re looking for privacy, you might find it in Nevada.
Finally, Wyoming has similar benefits to Nevada. This state also allows for maximum privacy, even allowing you to designate a proxy to act as an LLC member on your behalf. When you throw in Wyoming’s reasonable business tax rates, it’s easy to see why entrepreneurs like forming LLCs here.
How does limited liability protection work?
The limited liability protections afforded by an LLC are often referred to as the “corporate veil.” This veil provides a layer of separation between your business and personal assets, preventing creditors from pursuing your house, car, personal bank accounts, and more while suing your business. Thanks to the corporate veil, only your business assets are at risk in a lawsuit. However, if you fail to form or maintain your LLC in compliance with state laws, your corporate veil could be “pierced” and you will lose your limited liability protection.
The limited liability company (LLC) is such a popular business entity type for a reason, as it combines some of the corporation’s advantages with those of informal businesses like general partnerships.
The result is a fluid and flexible business structure that still maintains its professionalism and legitimacy.
Still, the point we would like to drive home is that the LLC is not for everyone. While it does have several significant advantages over the corporation (as well as over informal entities), there are also some disadvantages that could apply depending on your exact situation.