LLC Advantages and Disadvantages

A limited liability company (LLC) is a legal business structure available to new and existing business owners. It's a popular legal entity because it offers owners tax flexibility and reduced risk to their personal assets.

While LLCs are indeed a commonly used business structure for their limited risk and pass-through tax structure, that doesn't mean they are the perfect structure for every business owner. LLCs have both advantages and disadvantages that are worth weighing before deciding to create one.

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Key Advantages of LLCs

• LLCs are more straightforward to establish than corporations
• They limit risk to an owner's personal assets
• They are financially flexible and offer pass-through taxation status
• LLCs provide flexible managerial structures
• Organizing your LLC lets businesses and customers know that you are legitimate business in the state

Key Disadvantages of LLCs

• Owners must pay registration and renewal fees
• Traditional corporations are generally more attractive entities to investors

Understanding LLCs

LLCs are a dependable entity structure for many small businesses. The "limited liability" in LLC refers to the structure's ability to shield an owner's personal assets from the company's debts and obligations. This differs from the sole proprietorship and general partnership, which do not protect an owner's assets.

This business structure type also offers pass-through taxation. Any taxes on a business's profits pass through the corporate level and are assessed as personal income on an owner's tax returns. Limited personal financial risk and pass-through taxation are both generally looked at as significant advantages for LLCs.

LLCs form when their owners draft an operating agreement and file articles of organization with the state. 

Advantages of LLCs

LLCs have a variety of advantages that make them an attractive business structure, particularly for small business owners. LLCs are:

• Easy to establish: LLCs are formed in a process called "organization." In most states, this involves owners drafting an operating agreement and filing articles of organization with their state. Operating agreements outline the business's financial and structural decisions so that owners are all on the same page. Articles of organization are typically a document filed with the state detailing the business's name, its address, and the name of a registered agent. This document and any necessary forms are filed for a fee. Alternatively, corporations involve more paperwork, are subject to more regulations, and include formalities such as requiring a board of directors.
• Limited personal financial risk: Under an LLC structure, the owners do not risk losing their personal assets. This is not a complete shield from being sued, and business owners can always be held financially accountable for their own behavior. Still, LLCs provide reassuring protection for owners if the company finds itself in legal or financial jeopardy. While corporate shareholders also have limited liability protections, sole proprietorships and general partnerships have no such shield.
• Financially flexible: An LLC's profits are distributed to owners according to their allotted share. Owners are also allowed to draw funds from their share of the profits. When an LLC chooses to be taxed as an S corporation (S-corp), its profits are not taxed at the corporate level. Instead, the gains are accounted for on an owner's personal income tax return. This structure avoids the double taxation structure of corporations that elect C corporation (C-corp) status.
• Flexible regarding ownership and management: LLCs can have one owner or multiple owners. These owners can be people or other business entities. Even though LLCs are a common entity chosen by small businesses, there are generally no restrictions on the number of owners an LLC can have. If they choose to be taxed as an S-corp, LLCs are limited to 100 owners. LLCs can be managed by their owners, or the owners can choose a manager.
• More dependable than sole proprietorships or general partnerships: With an owner's personal assets protected, organizing comes with the added advantage of letting everyone know you mean business. It is a signal to other businesses and potential customers that your business's affairs are in good legal standing and working order.

Disadvantages of LLCs

LLCs are not for everyone. They have certain drawbacks worth considering:

• Registration and filing fees: While LLCs are easy to set up, most states charge filing fees ranging between $40 to $500. These fees are a consideration that new owners should research, especially sole proprietors looking to shift to an LLC. Additionally, most states require LLCs to pay yearly renewal fees. While it may seem costly, it's important to remember that not having limited liability can sometimes prove more expensive to you personally.
• Corporations are more attractive to potential investors: LLCs can't issue stock or raise capital. For these reasons, they are not as attractive to investors seeking large amounts of growth over a long period. If business owners plan to raise money in the future by selling additional shares, an LLC is not the legal entity for them.

Deciding What is Best for Your Business

Starting a new business is always challenging. There is no road map for new owners to follow. When you're weighing options and deciding which business structure is proper for you, you should strongly consider using a reputable DIY business formation service or contacting a small business lawyer. Their know-how and legal advice will help you face these challenges with confidence.

Related Topics

• Corporation versus LLC
• Limited Liability Company FAQ
• Corporations
• Tax Differences Between C and S Corporations