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What is an LLC?

llc, business agreement
LLCs can be started by just one owner or have multiple members.
Credit: Pressmaster | Shutterstock

One of the first steps to forming a new business is determining the type of structure it will take. One relatively new structure is the LLC.

Limited liability company

An LLC is a limited liability company. It is a legal structure that combines the benefits of a corporation and a partnership. LLCs provide their owners — which are called members in this structure — with limited liability protection, like a corporation, while also affording the business special tax breaks like a partnership.

LLCs are formed by filing Articles of Organization with the Secretary of State's office in the state where the business will be located. Each state is different, so business owners must know the rules and regulations of forming an LLC in each state in which they plan to operate. LLCs can be started by just one owner or have multiple members. Members don't all have to be individuals. Owners of an LLC can also include other companies and foreign entities. Since there is no maximum amount, an LLC can have as many members as it wants.

After an LLC is formed, an operating agreement is written that spells out the rights, responsibilities and amounts of profits and losses to which each member is entitled. Since each member invests a different sum, the amount of profits and losses they share in will all be different. An LLC can also go through a process of adding members at any time after the formation of the business. [Related: How to Choose the Best Business Entity]

Benefits of an LLC

Having limited liability protection is beneficial to business owners because it provides a safeguard against them being held personally responsible for any debts or lawsuits that the business may incur. Should the business fail and creditors come calling, only assets of the business itself, and not the owners, can be seized, providing added protection for things like a business owner's home and personal savings.

Another large benefit is that LLCs are not subject to federal taxes. Instead, the profits and losses of the business are passed onto each owner, who then pays personal income taxes on that. This avoids double taxation and gives owners a better opportunity to keep as much of the profits as possible. Another benefit to an LLC is the flexibility in which it can be managed. The business can either be member-managed, which means the day-to-day responsibilities are handled by the owners themselves, or manager-managed, meaning the owners bring in someone from the outside to handle the daily needs of the business.

Other advantages include not having to hold regular shareholder meetings, significantly less required record-keeping and the fact that they can be started much easier and more cheaply than a regular corporation.

Disadvantages of forming an LLC include the higher self-employment tax that owners are subjected to and the fact that many states restrict the types of businesses that can be formed via an LLC.  For example, most states prohibit businesses in the banking and insurance industries from forming an LLC.

Forming an LLC

Most entrepreneurs can set up an LLC in a few easy steps and without the assistance of a professional. Among the initial steps needed to create an LLC:

Pick a name: Owners need to choose a name that meets all the requirements of the state where it is being formed. The name can not already be in use by another LLC and must include LLC or Limited Liability Company at the end.

File papers with the state: Owners of an LLC must file Articles of Organization with the Secretary of State's office. Articles of Organization include basic information on the newly formed business, including its name, members and address. They also designate who will run the business, the members or a manager, and who the resident agent — the person who is legally allowed to receive documents on behalf of the business — will be. In addition, business owners should check whether there is any other type of registration required in their state.

Prepare an operating agreement: Once the business has been approved by the state, it is critical that the business owners draft an operating agreement that spells out the roles of each owner and how much money each will be entitled to.

Announce the business: While not all states enforce this, some states require that new LLCs announce their opening by publishing news of it in a local newspaper.

Get permits: Depending on the type of business, there may be certain city or state permits that need to be acquired before opening.

Retain a lawyer: While it isn't necessary or required, many business owners feel more comfortable having a lawyer review their operating agreements and other pertinent documents to make sure everything is up to snuff.

Once these steps are complete, an LLC can legally open at any time.

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