The idea of forming a limited liability company (LLC) appeals for many reasons.
An LLC is a legal entity separate from its owner. It offers better asset and liability protection than a sole proprietorship: your liability is limited to the assets held by an LLC. No one can go after your personal property. At the same time, this business structure comes with some extra administrative upkeep, filing and operating costs.
Do you need an LLC to run a successful small business venture? Let’s decide together.
Do I need an LLC to start a business?
The short answer is no. You don't need to form an LLC to start a business.
In fact, most entrepreneurs begin as sole proprietors. Unlike LLC, a sole proprietorship is an incorporated form of operating a company.
You don’t form a legal entity — instead, you just operate as an independent contractor (self-employed person). So legally, you are allowed to run a business without incorporating an LLC. But LLC formation makes a lot of sense when your business starts growing, and you want to attract more capital, e.g., by having a business partner or applying for a loan. LLC business structure is also recommended if you are in a professional services business or a business that carries a substantial risk of injury or litigation.
The risks of running a business without an LLC
LLCs offer more protections to business owners than sole proprietorships.
If you ever run out of money or get sued, creditors or plaintiffs can only go after your LLC assets, not your personal assets. Likewise, in most cases, you can’t be held liable for damage done by your company (or its employees and subcontractors).
When you run a business without an LLC, you may be personally held liable by:
Then, there are internal operational risks.
If you run your business as a general partnership, you are less protected from your partner’s actions. Conflicts and disputes are hard to resolve since you lack legal documents and binding agreements.
Forming an LLC involves the creation of an LLC operating agreement that outlines roles, responsibilities, allocation of profits/losses, and a structure for the business to be successful.
What protections does an LLC offer?
A limited liability company separates you (as a private individual) from your business entity (an LLC).
It protects your personal assets — cash, property, etc. — from any business liabilities. You can also benefit from greater privacy as many states don’t ask to disclose all LLC members on company formation documents.
Finally, as a business owner, you won’t be held liable for any negligence caused by employees and other LLC members. The business will bear the brunt.
The main benefits of an LLC include:
- Personal asset protection
- Personal liability protection
- Ability to bring in multiple partners and raise capital
- More financing options
- Tax advantages, and tax benefits
Read more about LLC protections business owners obtain.
When to change from a sole proprietorship to an LLC?
You can convert your sole proprietorship to an LLC at any stage of your business. But the best time to do so is after the first year of operations. You’ve already tested your business for viability and are ready to go bigger!
Changing to an LLC also makes sense at the beginning of the new income tax year, as you’d struggle less with accounting.
To convert your sole proprietorship to an LLC, you’ll need to complete these steps:
- Select a business name for your LLC
- Choose a registered agent
- File the “Articles of Organization” form with your state Secretary of State
- Open a business bank account
- Draft an operating agreement for your LLC
- Get an employer identification number (EIN) — if you plan to have employees.
- Renew or obtain any required business licenses/permits
For more information, check our guide to switching from a sole proprietor to LLC.
Setting Up Your LLC
LLC formation is a smart way to protect yourself and your assets.
You also establish more “authority” around your business and access more financing opportunities. You can also switch from operating solo to having business partners (or investors) and raise capital from abroad.
Finally, LLCs benefit from flexible taxation policies, leading to savings. You also get more ways to pay yourself as an LLC owner — you can take an owner’s draw, issue a salary, issue guaranteed payments, or make profit distributions.
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