At What Point Should Your Business Become an LLC

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Whether you’re a freelancer or independent contractor, it’s likely you consider yourself as a person running their own business – but it’s more than a mindset. Becoming a real business owner requires a little more paperwork.

If you’ve been wondering whether you should incorporate or become an LLC, there are several factors you’ll need to consider before making a decision. And while incorporation is also an option, for this article we’ll be focusing on an LLC as it is a more flexible business structure and allows you to make additional income, work for other people, and keep your personal life separate from your business.

Keep reading to find out whether an LLC is right for you, and how to start the process.

What is an LLC?

An LLC is a business entity that is owned by and operated by one or more people. Unlike a sole proprietorship, an LLC is a business structure where there is a separate legal entity that you own, but where you’re still responsible for the business’s assets and obligations.

An LLC differs from incorporation, such as forming an S Corporation, although they’re often confused in layman’s terms. An LLC is an entity with its own limited liability, meaning it is not as susceptible to personal liability. It’s in the name – Limited Liability Company.

Basically, the LLC owner is protected from personal liability, as are the entity’s assets, when the LLC itself is a separate entity and not a subsidiary, or controlled by the LLC owner.

Let’s say, for example, that the LLC goes into debt – the LLC owner cannot be personally sued by those seeking repayment, unless the LLC member personally guaranteed the debt.

Overall, forming your business as an LLC structure generally allows for more flexibility not only in personal liability protection, but also tax benefits, the ease of starting an LLC compared to other company structures, and the credibility the LLC name is granted as an authentic business entity.

Setting Up Your LLC: Creating an Operating Agreement

An LLC operating agreement is a legal document that defines the business entity’s responsibilities and powers. This is used to determine the division of control within the business, as well as a mechanism to make sure members follow the operating agreement.

In other words, let’s say that you form an LLC with two of your best friends. An operating agreement will explicitly outline each LLC members’ role and responsibilities, and can also contain additional clauses, such as profit sharing and capital investment.

Remember The Social Network, the documentary-drama which was all about Facebook’s beginnings and the falling out between Mark Zuckerberg and Eduardo Saverin? Well, that was all basically a big LLC operating agreement dispute (that’s an oversimplification, but pretty accurate).

Business and money can change people, and “trust between friends” isn’t worth a grain of salt in the long run. That’s why it’s important to have an LLC operating agreement that spells out how each of the LLC members will handle business operations.

When Should You Form an LLC?

Forming an LLC is a decision that needs some consideration, so you need to decide whether it’s right for your company. In general, it’s not a good idea to form an LLC for a business that is a sole proprietorship, unless you have very specific business requirements.

One of the main reasons for this is that an LLC is a separate entity and legally the owner of the LLC is different from the business owner.

In order to set up an LLC, you’ll need to have a signed operating agreement that outlines the responsibilities and powers of each LLC member. If you’re not legally bound to the operating agreement, it’s better to avoid setting up an LLC.

If you’re an independent contractor, it’s typically better to form yourself as a sole proprietor. An LLC is more appropriate when you have multiple business partners, and the company needs to be fairly structured.

Do check our Business & Startups section for more such articles on running a successful business.

Cover Photo by krakenimages on Unsplash

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