In the last issue of CBN, we briefly examined the “S” corporation, and its pros and cons. Let’s explore another possibility. As you’ve probably noticed, limited liability companies, or LLCs, are everywhere.
Why hadn’t you seen them much until fairly recently? Well, the LLC has an interesting—but rather brief—history. The form was first used in Wyoming back in 1977. By 1988, the Internal Revenue Service had recognized it nationally as the rough equivalent of the partnership, at least for tax purposes.
Following this 1988 decision, LLCs have become increasingly popular. In 2009, more than half of new business forms were LLCs in many states. Why do a great number of entrepreneurs prefer the LLC to the corporation? It’s a good question, without totally definitive answers. One reason is that the LLC isn’t quite so loaded down with unique eligibility requirements. Here are some other advantages:
• Flexibility of operation. Although the LLC has to submit “articles of organization,” similar to the articles of incorporation in the corporate form, it does NOT have to keep minutes or hold annual stockholder meetings. Like a partnership, the LLC has to submit an “operating agreement” which tells how the firm will operate as an LLC. That isn’t terribly demanding.
• More liberal ownership rules. We mentioned last issue that “S” corporations are allowed only a limited number and type of ownership. In an LLC, the owners can be partnerships, individuals, or even corporations.
• Choice of taxing approach. The owners of an LLC can decide whether they want to be taxed as a partnership or as a corporation. Partnership-level taxation can be a real advantage, especially for a very small company. And, it’s nice to have a choice.
• More flexible payment of both profits and losses. In a corporation, profits (and losses) are usually distributed to stockholders on the basis of their individual investments in the company. In an LLC, the members agree who will get what percentage of the profits, regardless of the amount they
have invested.
• Limited liability for losses. This is certainly the biggest advantage of the LLC over the partnership. Limited liability means that people who choose to invest in the company, put only the money they invest at risk—rather than their house, car, and other personal assets. Of course, any form of corporation will give you the same advantage.
Before you decide that the LLC is definitely for you, take a look at the disadvantages presented by this business form:
• Paperwork issues. If you really hate paperwork, you might want to stay with the sole proprietorship. However the LLC requires quite a bit less paperwork than any of the forms of corporation.
• Tax issues. Unlike “S” corporations, LLCs have to pay self-employment taxes (Social Security and Medicare taxes). Examine this disadvantage closely; it’s an important one.
• Mortality. Unlike a corporation (which is technically immortal), an LLC has a limited life span. When you first file for an LLC, you are required to identify the date of termination of your business—at least as an LLC. When a member dies, the business often ends, as well.
• Absence of stock. This is a disadvantage that is really worth taking a look at. First of all, you can’t just choose to issue some new stock when you need to expand. Nor can you use stock incentives to motivate your employees. If issuing stock is important to you, take a long, hard look at the realities of the LLC.
The limited liability company just might be your way to go in the future. Before you decide, get more information, and look at your own needs. The LLC has to be right for both you and your business, now and as it grows in the future. For more detailed information on the LLC, check this site: http://www.companiesinc.com/llc/why.asp.
Lowell Lamberton is Professor of Management at Central Oregon Community College. You may call Professor Lamberton at 383-7714 or e-mail him at llamberton@cocc.edu.
