Choosing and forming a business entity is a crucial milestone in your company’s growth. It’s also a testament to all the hard work you’ve put in so far. You already know how to start a small business, and started expanding the products or services you offer. Now, you’re ready to take the next big step – forming an LLC.
An LLC (Limited Liability Company) is a favored business entity choice for many entrepreneurs. While a sole proprietorship is a great business structure for early, humble beginnings, you can quickly grow from it and find it too confining for further expansion.
The main benefit of forming an LLC is that it allows you, as a business owner, to separate the business from yourself in the eyes of the law, turning it into an independent legal entity. This provides you with liability protection, meaning that you won’t be responsible for any business debts that the LLC incurs, protecting your assets from seizure.
If you’re looking into how to start an LLC, we’ve prepared a simple-to-understand guide for you to follow.
Table of Contents
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What is an LLC?
Before you head down the path to forming an LLC, it’s paramount to get to know what they are and how they function. Only then can you make a truly informed decision on whether to form an LLC and whether it’s the best choice for your small business.
As we touched upon in the introduction, an LLC, short for limited liability company, is a type of business entity. Entities represent different types of organizations formed by an individual or individuals to conduct business.
The different types of business entities present in the United States are:
- Sole proprietorship
- Limited partnership
- General partnership
- LLC
- C corporation
- S corporation
- Non-profit organization
The LLC are organizations recognized by the state and federal authorities as single entities and treated as separate from their owner(s). This separates them from sole proprietorships, and for many people the easiest way to understand LLCs is to compare them to sole proprietorships.
Sole proprietorships are businesses that aren’t legally separated from their owner, which is why many of them operate under the owner’s actual name. The owner of a sole proprietorship pays income tax on profits earned by their business and is considered liable for any business debts. This puts their assets in danger if they can’t repay those debts, as those assets may be repossessed to pay off the dues.
On the other hand, an LLC is a corporate structure that protects owners’ personal assets, preventing owners from being treated as personally responsible for their company’s business debt. Unlike sole proprietorships, which are easy to form or break up and are loosely regulated, LLCs are required to go through a specific legal process to be recognized by the state.
Another point of separation for LLCs compared to other entity types is that members manage it. Thus, everyone who has an ownership interest in the company is treated as a member. Other than that, LLCs are free to determine their management structure. This is in stark contrast to corporations with a somewhat rigid management structure consisting of shareholders, directors, and executives.
Last but not least, business partners in an LLC can choose not to pay federal texas. How LLCs then pay taxes is through each member’s personal tax return. Both profits and losses of the LLC are reported on that tax return. Since taxes are “passed through” to members of an LLC, this is referred to as pass-through taxation.
Now, you should have a pretty clear idea of what LLCs are and how they’re different from some other common types of business entities. So now, let’s evaluate the advantages LLCs confer on a small business, as well as what the disadvantages are.
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Pros and Cons of an LLC
LLCs are often described as an ideal middle ground between corporations and sole proprietorships. Unlike proprietorships, LLCs give you personal liability protection without the rigid structure and double taxation of corporations.
The most significant advantages of forming an LLC are:
+ Limited liability protection
+ Pass-through taxation
+ Less paperwork than with a C or S corporation
+ Flexible structure
On the other hand, there are also some disadvantages you should know about before deciding to form an LLC.
-In some states, an LLC is forced to dissolve if one of the LLC members leaves or dies
-More expensive to create than a sole proprietorship
-Not ideal if you plan to take the company public
With clear pros and cons out of the way, let’s get to the central part – how to form an LLC.
How to start an LLC: a step-by-step guide
Step 1: Choose a business location
The first step you need to take to start an LLC is to choose the state you’ll operate in. Usually, the wisest choice is to choose the state you live in as your base of operations. However, if you have a physical presence in other states (offices or stores), you’ll need to register a new LLC in each state, which incurs extra fees and costs.
Choosing a state in which to form a limited liability company is a pretty big decision, and there are several things you’ll need to keep in mind. You should first consider the needs and capabilities of your business specifically, such as operational costs, the location of your target audience, and the supporting infrastructure you’ll have for working in each state.
Secondly, small business owners should scout out whether the state they’re considering has any incentives to attract new business. This can often make your life much easier, reduce costs, and quicken growth. Lastly, prospective LLC owners need to check each state’s specific rules and requirements for forming an LLC. They can be found on the SBA’s website. The steps we present here present are general guidelines – we strongly advise that you consult state-specific regulations for LLC formation in the state you’re looking to do business in.
Step 2: Choose a business name
Now that you’ve chosen the ideal state for your LLC, you’ll need to choose a business name. Choosing a name is essential for multiple reasons. First, LLC owners should choose a name that reflects what they do and gives them the potential for building up their brand.
Secondly, most state laws forbid you from utilizing a name already in use in the state – even if the LLCs are located in different cities. Also, your business name is forbidden from containing words that might imply government affiliation or misrepresent what you do. This often includes words like “bank”, “credit union”, “university”, “FBI”, etc.
Lastly, you’ll probably be required to add the word “LLC” or “limited liability company” at the end of your business name.
To summarize, the things to keep in mind when choosing a business name are:
- See whether the name is already in use in the state in question
- Do not use words like “bank”, “lawyer”, or “US” that misrepresent your business or imply government affiliation
- Include “limited liability company” (or abbreviations like LLC or L.L.C.) at the end of your business name.
Step 3: Choose a registered agent
One of the universal requirements for LLCs in the United States is to designate a registered agent. A registered agent is a person designated by an LLC or corporation to receive correspondence from the government on behalf of your business. These correspondences include tax and legal documents, compliance documents, and lawsuit notices.
Don’t worry, there aren’t too many prerequisites for a person to be designated a registered agent. There are only three major boxes to tick:
- The person has to be at least 18 years old
- The person needs to have a physical address within the state of operation
- They need to be available at that address during regular business hours
As you can see, pretty much anyone can be designated as the registered agent for your LLC. They’re practically just people the government can reach out to ensure your company receives important notices and documents.
Even LLC members can be chosen to act as registered agents. However, the LLC itself cannot. Besides appointing yourself as your LLC’s registered agent, you can hire a professional one if you don’t want to deal with the hassle.
Step 4: Create an LLC Operating Agreement
After choosing a registered agent, you should sit down with other LLC owners (if any) and create an LLC operating agreement. The operating agreement your LLC’s business structure and defines member duties.
An operating agreement is usually not legally required by state authorities, as it is an internal document that isn’t filed with any office. However, all LLCs are strongly advised to draft an operating agreement to clearly define how the business will run and be managed.
One of the most critical elements of an LLC operating agreement is defining the management structure. LLCs can be operated in two ways: by the member(s) themselves or by appointed managers.
In a member-managed LLC, the members will directly take care of the business’ day-to-day, handling all critical decisions. Alternatively, in a manager-managed LLC members delegate their responsibilities to a manager or managers they appoint.
In general, the LLC operating agreement should contain the following sections:
- Organization – this segment covers the company’s creation, who the members are, and the ownership structure.
- Management and voting – determines whether the LLC is member-managed or manager-managed.
- Capital contributions – shows which members contributed financially to the LLC and covers how funds will be raised in the future.
- Distributions – covers how profit and losses are shared between members.
- Membership changes – defines how members are added or removed
- Dissolution – determines when the LLC can or has to be dissolved.
Step 5: Prepare and file the articles of organization
Now comes one of the most important steps small business owners undertake during the LLC formation process: preparing and filing the articles of the organization. The articles of organization are legal documents that establish your LLC as a legal entity.
They are mandatory for LLCs to file and they are the ones that create your LLC officially. In some states, this document is also referred to as a “certificate of organization” or a “certificate of formation”.
Each state has a specific form, which can be found on state-designated websites that contain other LLC documents. In most cases, you’ll need to provide the following information:
- Business name
- The address of your main office
- Name and address of the registered agent
- The nature and purpose of your business
- The way the LLC will be managed
- Names and contact information about founding members and managers
- Duration of the LLC: will it be perpetual or indefinite
In the majority of states, the articles of organization are filed with the Secretary of State. When filing the documents, you’ll also have to pay a state filing fee. These fees range from $50 to $500, depending on the state.
After successfully submitting the articles of the organization, make sure to obtain the state certificate that confirms the creation of your LLC from the filing office.
Step 6: Obtain an EIN
For tax purposes, you’ll also have to have an EIN ( IRS Employer Identification Number). The tax id number is needed if you plan to hire employees or open a business bank account. In case your LLC has more than one member, you’ll be required to obtain an EIN. For one-member LLCs, you’ll need to get an EIN if you plan on hiring employees or want to get your LLC taxed like a corporation (discarding the pass-through entity tax benefits). Your company’s EIN can be obtained for free on the IRS website.
Step 7: File annual reports
In some states, you’ll be required to submit annual reports and pay filing fees every time you do. Check with state authorities whether these reports are required and obtain the state-specific report forms if they are.
The Last Word
That’s it, you just went through all the major steps of starting an LLC! As we previously mentioned, you need to see the specific LLC registration procedures for the state you plan to work in. However, this guide should cover all the most critical steps you need to take.
Here’s a summary of all the steps for creating an LLC:
- Select a business location
- Choose a business name
- Choose a registered agent
- Create an LLC operating agreement
- Prepare and file the articles of organization
- Obtain an EIN
If you followed through with all the steps, you should now be in charge of an official, fully operational LLC.