1. Money
Send to a Friend via Email

Limited Liability Companies for Beginners

A New Investor's Guide to Understanding LLCs

By

Limited Liability Company Formation LLC

A limited liability company or LLC is a relatively new business structure that offers the benefits of a partnership and a corporation in a single investment vehicle. LLCs are cheap to form and easy to manage compared to other incorporation choices.

Over the past fifteen years, limited liability companies have become one of the most popular ways for investors to structure their holdings, beating out limited partnerships. From families that pool their money together to Fortune 500 corporations that have subsidiaries, you may have directly or indirectly invested in an LLC without knowing it. This overview was designed to help you understand what LLCs are, why investors use them, and some of the factors you may want to take into consideration before you form an LLC or invest in one.

The Benefits of Limited Liability Companies

A limited liability company, or LLC as it is often known, is a type of business that combines the benefits of a corporation and a partnership. For example:

  • Taxation: An LLC can elect for either corporate-level taxation or pass-through taxation. That is, you can decide to have the company pay taxes on its earnings as a regular stock corporation would, or you can have it prepare K-1 statements for each investor showing their pro-rata portion of the profits and losses, which they then declare on their own personal income tax filings. In many cases, this can result in more profits flowing through to the owners because those in lower tax brackets pay less to the government than they otherwise would and the avoidance of double taxation on dividends.
  • Member vs. Manager Operation: Instead of shareholders, LLCs have “members”. An LLC can be either “member managed” or “manager managed”. In a member managed limited liability company, all owners have a say in day-to-day decisions. In a manager managed limited liability company, the members elect managers to run the business and these managers handle the daily work, often for salary and wages.
  • Tremendous Flexibility for Profit and Loss Allocation: Profits and losses can be divided virtually any way that is compatible with tax law, unlike with a corporation where everything has to be divided pro-rata. If you and your family formed an LLC to start a restaurant, you could write the contract that governed the business (known as the “operating agreement”) to meet your needs no matter how complex; e.g., certain family members who only owned 2% of the business could be paid a percentage of sales plus no losses would count against their stake. In a stock corporation, if you own 2% of a company, you have to take 2% of all profits and all loses, giving you much less flexibility.
  • Limited Liability for All Investors, Including Managers: Unlike a limited partnership, where the managers, or general partners, have personal liability for the business debts and liabilities, in a limited liability company, no one is personally on the hook unless they agree to be in a contract, such as a commercial bank loan that requires a personal guarantee. (If investors in an LLC don’t keep enough distance, courts have allowed investors to become personally liable because they “pierced the corporate veil”.)
  • LLCs Have Far Fewer Meeting and Paperwork Requirements: A stock corporation is generally required to file regular paperwork with the state in which the business is formed, as well as publish annual reports, have regular board of directors meetings, and much more. A limited liability company, on the other hand, requires virtually no upkeep. Meetings can be as formal or informal as you wish, as long as everything is properly documented and you don’t treat the business as an extension of your personal assets.
  • Cheap Formation Costs: Limited liability companies can be established for very little money. For simple LLCs among family members, this can require only a few hundred dollars. In fact, you can even use one of several online legal services to file your paperwork, provide fill-in-the-blank operating agreements, blank limited liability company membership certificates, embossed binder, LLC seals, and more.

More Information about Limited Liability Companies or LLCs

For more information, read our New Investor's Guide to Limited Liability Companies or LLCs.

©2014 About.com. All rights reserved.