- An LLC is a business structure where business owners are not held liable for the company's debts and can choose their own management structure.
- Pass-through taxation is a major benefit of LLCs, as profits are taxed only once.
- There are seven major steps to set up an LLC.
- This article is for new entrepreneurs who are interested in learning how to start their own LLC.
One of the most important steps in starting a small business is deciding on a business structure. There are many to choose from, each with its own advantages and features. For most small business owners, an LLC is a great choice because of its simplicity, flexibility and ability to protect personal assets. This article will explain what an LLC is, its advantages, and the seven steps you need to take to set one up yourself.
What is an LLC?
An LLC, or limited liability company, is a business structure that shields business owners from being personally liable for the company's debts or other liabilities. It is a hybrid entity that combines the benefits of partnership and sole proprietorship structures. LLCs can be owned by one person or by multiple people, known as LLC "members."
An LLC provides protection from personal liability in most cases by keeping your personal assets – such as your vehicle, house and savings accounts – safe if your LLC declares bankruptcy or is sued.
Single-member LLCs are pass-through entities, so the profits and losses from the LLC are "passed through" to you and taxed as personal income. The benefit of this is that you don't have to pay both corporate and personal taxes on your earnings. Similarly, multi-member LLCs are taxed as partnerships – which are also pass-through entities – with each owner paying personal income taxes on their portion of the profits.
Key takeaway: An LLC is a flexible business structure that protects the owners' personal assets.
Benefits of an LLC
An LLC structure provides many benefits for your business besides the liability protection. These are the main advantages:
Personal asset protection: As long as you have not committed fraud or any criminal act as an LLC member, you are not personally responsible for the LLC's debts or lawsuits.
Pass-through taxation: An LLC's profits go directly to the owners, who report their share of the profits on their personal tax returns, so the business's profits are only taxed once. In a C-corp, for example, profits are subject to double taxation, meaning the business is taxed on its profits and then again when the owners report their earnings from the business on their tax returns.
Simplicity: LLCs are easy to create and maintain, with little paperwork and few requirements such as formal officers, annual meetings, or complicated company records.
Flexibility: LLCs have little restrictions regarding the structure, ownership and management of your company, meaning your business can be a single- or multi-member LLC, a member-managed LLC, or a manager-managed LLC. You can also choose the method of taxation that is most beneficial for your business.
Credibility: Forming your business as an LLC brings credibility, as LLCs are a widely recognized business structure that lets customers know you are serious and professional in how you run your business.
Access to business loans: After your LLC is formed, you can start building a credit history, which will enable you to access business loans and lines of credit to help you further build your business.
- Flexible profit distribution: LLCs can choose how they distribute profits to the owners – the distribution is not required to be equal among members or proportionate to ownership percentages.
Key takeaway: An LLC is easy to form and has few maintenance requirements. One of the main benefits of this structure is that your business is taxed as a pass-through entity.
How to start an LLC
Once you've decided to proceed with forming your business as an LLC, there are a few steps you have to take to get you to your goal.
1. Select your state.
The first thing you have to do as an LLC owner is select the state in which you will operate your LLC. For most new business owners, the most logical option is to form the LLC in the state where you live. If your business will have a physical presence (i.e., a storefront or office) in other states, you will need to register a foreign LLC in each state where you plan on doing business.
There are some situations in which you might choose to form your LLC in a different state from where you live. A few states, like Delaware and Nevada, have business-friendly laws that may attract potential LLCs. However, registering your LLC in another state (or multiple states) can incur costly fees and extra paperwork. [Read related article: How to Expand Your Business to Another State]
2. Name your LLC.
After you've decided where to set up your business, it's time to choose a business name. Each state has different rules for business names, but in general, you can expect to follow these guidelines:
- The name must include the phrase "limited liability company" or an abbreviation (LLC or L.L.C.).
- The name cannot include words that could confuse your business with a government agency (FBI, Treasury, CIA, etc.).
- Restricted words such as "bank," "attorney" or "university" may require additional paperwork and the inclusion of a licensed individual, such as a doctor, to be part of your LLC.
3. Choose a registered agent.
A registered agent is a person or other business that sends and receives legal documents on your behalf. These documents can include legal summons or document filings that your registered agent will receive and forward to you. Most states require LLCs to use a registered agent, and the agent must be a resident of the state in which you are doing business.
4. File with the state.
Your next step will be to register your LLC with the state. In most states, the formation document is referred to as the "articles of organization," but it can also be referred to as the "certificate of formation" or "certificate of organization." This document, along with your state filing fee, is what officially creates your LLC. You can send in your documents by mail or online.
5. Determine your management structure.
As an LLC, you have the ability to choose how your business's management will be structured. You can have your company be member-managed, meaning there is a small number of LLC members who are all involved in the day-to-day running of the company, or manager-managed, where members do not wish to be involved in managerial matters and place that power in the hands of one (or more) managers.
6. Create an LLC operating agreement.
An LLC operating agreement is a legal document that outlines the ownership structure and member roles of your LLC. Most states do not officially require an operating agreement, but it can still be beneficial to get everything down on paper. These are some of the sections in an operating agreement:
- Organization: This section outlines when and where the company was created, who the members are, and the ownership structure.
- Management and voting: This section addresses how the company is managed and how decisions are made.
- Capital contributions: This is where you'll designate which members financially support the LLC and form a structure for how more funds will be raised in the future.
- Distributions: This shows how the company's profits and losses are shared amongst the members.
- Dissolution: This section explains the circumstances under which the LLC may be dissolved.
[Read related article: Your Small Business Guide to LLC Operating Agreements]
7. Get an EIN.
An EIN, or Employer Identification Number, acts like a Social Security number for your LLC. You will need an EIN to hire employees and open business bank accounts. You can get an EIN for free from the IRS website, or via fax or mail.
Key takeaway: There are seven main steps in creating your LLC. Start by choosing a business name and the state where you will run your business.
What to do after starting an LLC
After you've started, named and filed your LLC, you still need to take care of a few things to get your LLC fully up and running. First and foremost, make sure to register your LLC for state taxes. If you are selling a physical product, you'll need to register for sales and use tax, and if you have any employees, you'll need to register with the state for unemployment insurance and withholding taxes.
Next, determine how you will do your accounting. You may choose to do it yourself, in which case you should research the best accounting software to help you keep track of everything. You may also choose to hire a certified public accountant to either help you set up or perform your accounting for you.
If your business needs a permit for any reason, now is the time to register for them. Certain business activities require permits at the federal level, such as alcoholic beverage sales, mining and drilling, transportation and logistics, and aviation. State and local rules around permits vary.
You should also strongly consider getting business insurance. Most states require some form of insurance, usually workers' compensation at minimum. General liability insurance is highly recommended, as it protects your business assets from lawsuits by covering injuries, property damage, personal liabilities, advertising liabilities and legal defense.
Finally, make sure you are following hiring laws at both the federal and state levels. These are the major requirements for hiring:
- Employees must be eligible to work in the U.S.
- You must report any new hires to the state.
- You must provide workers' comp insurance to employees.
- You must withhold employee taxes.
- You must print compliance posters and place them in visible areas of the workplace.
- You must pay employees at least minimum wage, as often as the state requires (weekly, biweekly, etc.).
Key takeaway: After you have followed the steps to create your LLC, your work is not done. There are still several actions you must complete as a business owner to set up your company for success and security.