Should one form an LLC?

An LLC works well in many situations, which I’ll detail below. However, it doesn’t really allow for shareholders so if you plan on bringing on outside investors then it’s probably not a great option for you. Many institutional investors like VCs have a framework that does not allow them to invest in LLCs.

Let’s compare and contrast an LLC from a C-corp, which is another popular business structure for founders.

Main Benefits of an LLC

  • Easy and cheap to set up
  • Not taxed as an entity

The best part about a LLC is you’re not subject to all the regulatory stuff like disclosures, costly accounting, etc. Therefore, it’s ideal for small businesses with a few people.

This means there’s a lot less paperwork involved when forming one. Annual state reports are required to be filed with a certain fee and you have to lay out who your “members” are and what percentage each one owns in the company. Some states like NY require you create an operating agreement which delineates the rules/responsibilities of the members (even if you’re just a single member LLC). But you don’t have to in CA.

Whether you’re required to have an operating agreement or not, it’s usually a good idea to have a lawyer draft one up for you. More on that here: Raad Ahmed’s answer to What does a startup operating agreement look like?

Another benefit is that the LLC is not taxed as an entity unlike a C Corp. In other words, profit or losses are passed directly to the members of the company, which are typically correlated by their ownership percentages. This is in stark contrast to C Corps where the company income is taxed at the corporate tax rate and shareholders also pay tax on the profits that are distributed (aka double taxation).

Regardless of the taxation style, you’re still able to avoid personal liability from the debts and liabilities incurred by the business. However, an LLC is not perfect and depending on the state you may be held liable for non-fiscal obligations.

But if you have any intention of raising money from investors with your new idea, the C Corp might be better choice for you. They’re suited for medium to large businesses with many shareholders (like investors and advisors).

There’s also a decent amount of formalities you must follow such as creating a board of directors, adhering to the reporting requirements, and generally keeping your finances and operations in check. You’ll have double taxation as I mentioned before, but it’s very easy to issue shares to many shareholders (why publicly traded companies are C Corps).

Hope that helps clear up some stuff. Starting a business on the side is a very exciting time period and I think you’ll enjoy the flexibility that an LLC will offer you. If you’re looking for a quick and cost-effective way to set up your LLC then visit LawTrades.