One of the essential steps to starting a business is determining the business structure you’ll operate under. Your choice of business structure should fit your needs, and for many entrepreneurs, an LLC is that choice. LLCs are the most common formal business structure used by small businesses in the US, according to the National Small Business Association (NSBA). LLCs are simple to manage and an affordable business structure that provides both limited liability protection and favorable pass-through taxation. In this article, you learn what an LLC is, the benefits of an LLC, and a detailed, step-by-step guide on starting an LLC.Table of Contents:
- What is an LLC?
- Why Form your Business as an LLC?
- How to Form an LLC
- What to do After Your LLC is Formed
A limited liability company (LLC) is a legal business structure established at the state level that combines limited liability protection, similar to a Corporation, and pass-through taxation like a Sole Proprietor or Partnership. LLCs can have an unlimited number of owners that are referred to as “members”.
Many entrepreneurs opt for LLC formation due to significant tax advantages and the flexible management structure associated with this type of business. An LLC company is also more affordable to establish and run than a Corporation. Unlike corporations, the law does not compel LLCs to appoint directors, establish boards, or host periodic shareholder meetings. Without these administrative requirements, you can focus on growing your business rather than holding compulsory meetings.2 Primary Advantages of Forming as an LLC:
The main advantage that an LLC provides is limited liability protection for its members. Since an LLC is legally recognized as a separate entity from its members (unlike a Sole Proprietorship or Partnership), it allows them to protect their personal assets. This is very beneficial if the LLC incurs business debts or is sued. If the LLC is forced to declare bankruptcy or has a lawsuit filed against it, the owner’s personal property like their homes, vehicles, and personal bank accounts are not at risk.
In addition to personal liability protection for its members, LLCs provide favorable pass-through taxation. Pass-through taxation allows the LLC’s profits (or losses) to be passed to the member’s personal income, bypassing the “double taxation” that Corporations are subject to by default in the US. This can allow for much less overall tax being paid on business income for an LLC than a Corporation. In addition to this, LLC can also file form 2553 with the IRS to request S-Corporation taxation status.
The process to legally form an LLC is done by completing registration at the state level. To start your business as an LLC complete the six steps listed below to learn how to start an llc and you can enjoy the benefits provided by creating an LLC.6 Steps to Starting an LLC:
- Select the state where you will form your LLC
- Determine the Legal Name of your LLC
- Choose a Registered Agent
- File your Formation Paperwork with the State
- Create an LLC Operating Agreement
- Get an EIN
While you can choose to form your LLC in a state different than your home state or where you operate, this is not recommended. If you form in a state where you do not operate, you will be required to also file as a foreign LLC in the state where you operate. As a result, this will increase your formation costs. If you attempt to form in another state and not register in the state you will operate in, you could be subject to fines and penalties. Because of this, we highly recommend that you form your LLC in the primary state where you will operate.
Before submitting any LLC formation paperwork, you need to choose an appropriate name for the venture. However, take note of state rules concerning naming your new company. Some of the standard requirements include:
- The name will need to include a designator such as “LLC”, “L.L.C.”, “Ltd.” or “Limited Liability Company”
- If you include restricted terms like attorney or bank, you should submit supporting documentation
- Avoid using words that confuse your entity with government agencies like CIA, IRS, and FBI
- LLC names cannot include designators for other entities like “Inc”, “Corp.”, “Incorporated”, “Corporation”
Looking for more in-depth information on how to come up with a great business name? Check out our step-by-step guide: How to Come up with a Business Name
Next you’ll need to determine who will serve as your registered agent or service of process agent. This can be any individual or an authorized commercial entity who has a valid physical address (P.O. Boxes cannot be used) in the state who will be available during normal business hours to receive important correspondence for your business.
What is a LLC Registered Agent?
A LLC registered agent is an individual or entity that has been designated by an LLC to receive service of process, government correspondence and other compliance documents from the state on behalf of the LLC.
Who to Designate as your Registered Agent
In general, people who form an LLC designate either themselves or another member of the LLC as the registered agent or choose a third-party commercial registered agent. While many LLCs elect to have one of their members serve as the registered agent for their LLC, there are some fairly major reasons why you may not want to do this.
Why we recommend not designating an LLC member as your Registered Agent:
- Registered Agent must always be available A registered agent must always be available to receive service of process documents and government correspondence. This means that if you list one of your LLC members and they are out of the office meeting with a client, out sick or on vacation these cannot be delivered. If these messages are not received they can have dire consequences. For example, if you were to be sued and your registered agent was not available to accept these documents you could have your company suspended or even involuntarily dissolved and shut down. In addition, the lawsuit could move forward without your knowledge and result it an automatic judgement against your company.
- You could be served a lawsuit in front of customers If you use your business address for your registered agent delivery it could lead to a very embarrassing situation. If you were to be sued, the notification of this service of process would be directed to your business address and could occur in front of your customers. This could be not only embarrassing but also very negatively impact the perception of your business in your customers eyes.
- Missing Important Filing Notifications and Alerts Your registered agent is also responsible for receiving important correspondence from the state regarding your business, such as tax and annual report or franchise tax due dates. Missing these filing and payment dates could result in your LLC loosing good standing including potential fines and penalties.
Why Choose a Commercial Registered Agent?
When it comes to choosing a registered agent we highly recommend using a third-party commercial registered agent service. Using a commercial registered agent can give you an extra level of peace of mind knowing that you are guaranteed to remain compliant. Commercial registered agents are professional services that guarantee that there will always be someone available to accept your service of process documents or government messages. Once they receive correspondence they are required to promptly inform you and forward any messages.
At the end of the day think of a commercial registered agent as a form of insurance. While you hopefully won’t need them for a more serious situation like getting sued, you don’t want to miss an important message and end up with major consequences. It’s a lot more affordable in the long run to pay a small annual fee to a registered agent than take the risk of not receiving important messages that could cost you significantly more money or could force your business to be shut down.
Once you have determined your the name of your LLC and who will serve as your registered agent you’re ready to file with the state. Most states refer to the formation document as “Articles of Organization” but a few states use different terms like “Certificate of Formation” or “Certificate of Organization”. By filing this document along with the required state filing fee your LLC will be officially registered. In the vast majority of state this process can be completed online or by mail. Each state’s formation document vary a bit but in general they will ask for a standard set of information.Information you’ll need to complete your LLC Formation Filing:
- The legal name of the LLC
- Business Address
- Names, Addresses and Contact Info for each member (owner)
- Name, Address and Contact Info for Registered Agent
- Effective Date if the LLC will start in the future
- Will the LLC be Member-Managed or Manager-Managed
Once your LLC formation has been accepted and your LLC is legally recognized by the state you will want to create an LLC operating agreement. An LLC operating agreement is a legal document stipulates the ownership percentage of members, their roles in the business and the ownership structure. Although most states do not require one, it is still highly recommended to create an operating agreement.
If you run your LLC without creating an operating agreement you could be setting yourself up for disaster. Having this document helps to protect an LLC’s main benefit: It’s limited liability status. If you conduct business without an operating agreement and are sued, one of the most likely things a plaintiff will attempt to do is discredit the LLC as a real business by “Piercing the Corporate Veil”. If you don’t have an operating agreement detailing formal processes of the business and who is responsible for which significant business tasks it can make it much easier case to argue that you are not a real business.
What is “Piercing the Corporate Veil”?
Without having an LLC operating agreement you can risk “piercing the corporate veil” by failing to maintain corporate formalities. If the corporate veil is pierced the owners of an LLC can be held personally liable for business debts and legal liabilities. This means that their home, car or personal bank account could be at risk.
You will also want to file with the IRS to get an EIN. The term EIN is an acronym for Employer Identification Number but can also be referred to as a Federal Tax ID or Federal EIN (FEIN). EINs are used by the IRS to identify your business. Think of an EIN as the equivalent of a social security number for a business. While not all LLCs are require to get an EIN, we advise that anyone forming an LLC obtain one since they are required to open a business bank account or if you hire employees.
Applying for an EIN is a free and can be done directly online via the IRS EIN Assistant. If you want to know more about EINs, how they work and details on how to apply review our guide, What is an EIN and How to Apply for One.
After LLC formation, you still have several steps to complete to ensure everything is ready before commencing operations. These steps include tax and employment registration, opening a business bank account, set up credit card processing, and other administrative tasks.Items to Completed After your LLC is Formed:
- Open a Business Bank Account
- Complete State Registrations
- Get Business Licenses and Permits
- Establish an Accounting System
- Set Up Credit Card Processing
- Sign Up for Business Insurance
To ensure that you maintain your limited liability status, you’ll want to open a separate business bank account for your LLC. If you don’t open a business only bank account for your LLC you risk co-mingling your personal and business funds. If you business and personal funds are not separated you could be subject to piercing of the corporate veil if sued. This would remove the limited liability protection an LLC provides and allow the person filing the suit access to your personal property. For more detailed information on this topic, check out our detailed, step-by-step guide on How to Open a Business Bank Account.
Once your LLC is formed you will also need to complete other state level registrations. The most common registrations for LLCs include getting a seller’s permit if you will sell retail items so that you can remit sales and use tax to the state. If you plan on hiring employees you will also need to register for withholding and unemployment taxes.
You’ll also need to ensure that you obtain all relevant business licenses and permits, which are a separate process from the formation of your LLC. The complete list of licenses you need depends on your line of business and, to some extent, location. By obtaining all the required permits, you avoid facing unnecessary legal complications. It’s important to note that business licenses and permits are issued at the federal, state, county and city level. As a result the process can be quite cumbersome to ensure that you are fully compliant. Because of this we recommend using a business license research service that can help you determine all the required licenses and permits your business will need.Common Business Licenses and Permits:
- Land use and construction permits
- Alcohol licenses and permits
- Natural resource licenses and permits
- Signage permits
- Health and safety permits
- Fire permit
- Professional licenses
- Building and zoning permits
Want to learn more about Business Licenses and Permits? Check out our detailed guide:
How to Get Business Licenses and Permits
A core part of any business will be establishing an accounting and bookkeeping system. By setting up a formal process for your accounting you’ll be able to get financial insights into your business’ performance and it will make obtaining loans and lines of credit much easier. The biggest accounting related choice you’ll make it determining the accounting method you’ll use:
- Cash Basis Accounting: Simplifies bookkeeping by recording transactions whenever payments are received.
- Accrual Accounting: A double-entry system that allows for more accurate documentation by including both accounts receivable and payables.
If you want a more detailed breakdown and guidance, check out Small Business Accounting 101: How to do Accounting for Small Businesses.
Whether your business sells products or services online or in physical stores, you need to set up card processing systems to handle payments. Mobile card readers are an option if your activities involve accepting payments while on the go. Your bank can provide point of sale (POS) systems to suit your needs, while platforms like Payoneer and PayPal offer a secure way to accept card payments online. An in-house card processing capability comes with several benefits for your business, including enhancing flexibility, boosting sales, increasing cash flow, and enriching the client experience.
For detailed breakdown of how credit card processing works and different providers on the market check out our guide, How to Accept Credit Card Payments.Small Business Insurance 101 Guide.