Once you have decided to go into business with someone (or several people), the next decision you must make is how to structure your new company. A Limited Liability Company (LLC) may offer you some benefits. LLCs are widely accepted as a means of structuring a business.
What is an LLC?
Is an LLC a partnership? Yes and no. The LLC is formed when the owners, or members of the company, enter into an Operating Agreement. For the LLC to be recognized by the state, like a corporation or partnership, the LLC must be registered with the Department of State. In this way, the LLC is more than just a handshake; it is a legal entity and, as such, is regulated by law. Following are general characteristics governing LLCs:
- A creditor may only reach a member’s interest in the LLC by means of a charging order, as determined by state law, regardless of whether the member is the manager of the LLC. Likewise, an LLC’s creditor may only reach assets of the LLC and not those of the member
- The LLC may be treated as a partnership for federal income tax purposes when it is owned by two or more members. Should the LLC elect to be taxed as a partnership, transferability of the membership interests may be affected
- Control of the LLC may be retained by a select few by utilizing different classes of voting interests among the members
Interests in the LLC can be transferred at discounted values, much like Family Limited Partnerships, thereby saving estate and gift taxes.
Generally, the owners of the LLC are referred to as “members of the company,” rather than as “partners.” Instead of owning stock, each member owns an interest in the LLC, much like a partnership. Most states require that at least two members enter into an operating agreement that dictates the structure of the LLC. An LLC has no restrictions on the number of members who hold an interest in the company or where the members live.
How do they differ from general partnerships?
One major difference between general partnerships and LLCs is the exposure to risk and liability. In general partnerships, each partner has a personal and unrestricted liability for the debts and obligations of the partnership. With an LLC, each member is liable only to the extent of what he or she has put into the company (the capital contributed). In this way, the members of the LLC enjoy the benefit of limited liability for the LLC’s debts. Furthermore, because the LLC is taxed as a partnership, most of the members’ profits are paid to them at their individual tax rates.
When to use an LLC
There are myriad uses for Limited Liability Companies and they can be utilized for a vast number of transactions. For instance, the LLC may be used as a means to raise funds, whether it is to fund a research project, or to attract investors for the development of a new tech company. Using an LLC for such purposes is attractive since it would provide limited liability for the investors while providing special allocations of research and development deductions and credits. An LLC could also afford the structuring of preferred returns to the investors. LLCs can also be used as vehicles for a leveraged buy-out, or to serve as a general partner in a limited partnership. LLCs offer tax advantages as well. LLCs can be taxed either as a corporation, or as a partnership. Choosing to be taxed as a partnership can avoid the double taxation that occurs with a “C” Corporation.
Potential downside of using an LLC
While LLCs offer significant advantages over general partnerships, there are potential pitfalls to consider. For example, while LLCs are recognized in all 50 states, each state has adopted different LLC statutes, thereby creating potential confusion when conflicts arise over which state’s laws apply. This lack of uniformity does not exist with partnerships, which are governed by the Uniform Limited Partnership Act.
Despite this potential downside, the Limited Liability Company offers flexibility in the structure of the company’s members, potential tax advantages, and the ability to minimize the personal risk and liability of the company’s owners.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.