Limited Liability Companies

Photo: Sara Kurfeß on unsplash.comThe simplest, yet most confusing, U.S. business entity is the limited liability company or “LLC.” This type of entity is extremely versatile, but requires some legal expertise to correctly set up and manage.

Who’s in charge?

A corporation typically needs to have certain governance structures: usually, this consists of a board of directors appointed by shareholders, which in turn appoints officers.

An LLC can either be directly managed by its owner (“member-managed”), or managed by one or more individuals appointed by the owner (“manager-managed”). There are also typically no mandatory officer positions. In a member-managed LLC, the member can sign on behalf of the LLC directly, or it may appoint officers and grant them the authority to do so. LLCs thus have a degree of organizational flexibility that does not exist for a corporation.

Taxed as a corporation? As a partnership?

For U.S. tax purposes, an LLC with a single owner is disregarded as a separate entity, while an LLC with multiple owners is treated as a partnership. In either case, an LLC can also choose to be taxed as a corporation separately from its owner (“C corporation”), or (depending upon its ownership) to be taxed as a corporation exempt from corporate taxation (“S corporation”). While the optimal choice has to be figured out on a case-by-case basis, this allows a tremendous amount of flexibility.

In the international context, it is important to understand that the election for U.S. tax purposes does not necessarily apply in other countries. For example, for Japanese tax purposes, an LLC will typically be treated as a taxable corporation. This can create benefits or problems depending upon how and where the entity will conduct business. (It’s  always a good idea to consult with a tax professional before choosing a business structure!)

When is an LLC a bad idea?

While LLCs allow for organizational and tax flexibility, they are generally not a great structure for businesses that intend to eventually IPO or take on venture capital. The LLC structure is optimized for businesses with a small number of owners, and in which equity interests will not change hands often. Corporations are generally a better choice for businesses that will eventually have many investors. It is possible to reorganize an LLC as a corporation, but if a business is predicated upon eventually having many investors, it’s generally best to start as a corporation.

Do you need a lawyer to form an LLC?

Single-member LLCs are relatively easy to set up and usually require minimal documentation. Many entrepreneurs choose to use an online form provider for the basic documentation. Legal advice is more useful with regard to ongoing operations in order to preserve the LLC’s limited liability and chosen tax status.

Multi-member LLCs require much greater care to set up, since the operating agreement and other constitutional documents will determine the rights and obligations of the members against each other, which can be of immense importance in the event of a dispute. Read more about the key provisions of these agreements here.