How to form an LLC: Benefits, setup, and operations for small businesses

When it comes to starting a small business or startup, many potential entrepreneurs think of setting up a corporation or simply operating the business as a sole proprietor. While both are fine, the former is complicated to set up and requires a lot of legal formality to operate properly. The latter, while easier to operate, lacks the limited personal liability that a corporation provides.

Fortunately, there is a middle ground that provides both limited liability and ease of operation — the limited liability company, or “LLC.” Another benefit of an LLC is that it is fairly easy to set up in most states and can often be done with existing resources that are customizable to the business’ needs.

Below is a helpful guide on the basics of forming an LLC, including helpful resources to get the new small business or startup up and running.

What are the benefits of an LLC?

An LLC is like a hybrid between a corporation and a sole proprietorship/partnership. The business owner gets the benefits of limited liability but the ease of operation of a small business.

Additionally, it is easy to set up with significantly less red tape and cost than a corporation. It is a popular entity choice for a business like a consulting firm, marketing agency, restaurant, and a host of other small or startup enterprises.

Advantages include

• Limited liability. If properly operated, an LLC provides separation and shielding of the entrepreneurs and their personal assets from the liabilities of the LLC.
  
• Flexible management. Since there is no required board of directors or officers, running an LLC day to day is generally much simpler than running a corporation. Despite the absence of a board requirement, many LLCs choose to set up boards of directors and adopt other processes common to corporations.
• Reduced formalities. As alluded to above, LLCs require much less in the form of corporate niceties such as mandatory record keeping, annual shareholder meetings, minutes, annual reports, etc.

Disadvantages include

• Limited ability to raise capital. When it comes to raising money from investors, it is much easier to do so if the small business is a corporation versus an LLC because the tax situation is less complicated when it comes time to sell the asset — though it is fairly straight forward to convert an LLC into a corporation. Also, if an LLC lacks more formal recordkeeping, a potential buyer may be leery of investing.
• Taxes, generally. Unless the owner chooses to be taxed like a corporation, the LLC profits will be taxed at the owner’s personal rate versus the corporate rate and the owner will be subject to self-employment taxes. It is smart to get professional tax advice when setting up an LLC.
• Flexible management. While more often an advantage, the “loosey-goosey” nature of an LLC can be a drawback, especially when roles and authority are not well defined among the owners.

For more on choice of entity and the pros and cons of each, including LLCs, see Practical Law’s Choosing an Entity Comparison Chart, Forming an LLC Checklist, and Certificate of (LLC) Formation (Delaware).

How to set up an LLC?

Though it is fairly simple to set up an LLC, it generally requires two things: filing a formation registration form with a state — typically an online form— and an operating agreement. For an LLC, it doesn’t matter too much which state law the LLC is registered under; many pick the state where they live since that is most convenient.

Others choose Delaware due to business-friendly laws, Nevada for low cost and no LLC operating agreement filing requirement, and Wyoming for low cost. An operating agreement is required in some states but, even if not, it is a good idea to have one in place, especially if there is more than one owner of the LCC.

Here are some other considerations when setting up the LLC.

• Choose a name. Be sure to do a rough Google search before selecting a name to make sure no one else is using it. And, remember to include the “LLC” designation when using the name — “ABC Consulting, LLC” or “ABC Consulting, a limited liability company” — in searches.
• Get a Tax EIN. The LLC should have its own tax identification number, or employer identification number (EIN). It is a smart idea to separate the owner’s SSN from the LLC’s tax ID, especially if it should be taxed like a corporation.
• Open a bank account. It is important to keep the assets of the LLC separate from the owner’s personal assets. Opening a dedicated business bank account is the best way to do this. Most banks require an EIN to open a business account.
• Identify a registered agent. This is the person who receives any legal correspondence on behalf of the LLC, such as notices from the state, lawsuits, etc. The registered agent can be the legal advisor or the owner of the LLC. There are numerous companies that, for a fee, provide registered agent services in all 50 states.
• Obtain the proper business licenses. Ensure awareness of any necessary licenses to operate the business. This includes local, state, and federal licenses. And, if business transactions will cross state lines, register the LLC in those states as a “foreign company.”

See Practical Law’s LLC Operating Agreement template and LLC Agreement Checklist

How to operate an LLC?

Once the setup process is complete, the owner is ready to operate the business! While an LLC has fewer formal requirements than a corporation, that doesn’t mean it should be the “Wild West,” either. If the small business has other owners — usually called “members” in an LLC — or if it has employees other than the owner, ensure the LLC protects all owners from lawsuits or, in unusual cases, direct liability for the actions of the LLC.

Tips to get started

• Keep bank accounts and assets of the LLC separate from the owner’s personal assets.
• If there is more than one member, have an operating agreement in place that deals with governance of the LLC, what happens if a member passes away or wishes to sell their interest, what happens if there is a deadlock, and a host of other thorny issues.
• Put the right employment agreements in place, including invention assignment, confidentiality, non-competition/non-solicitation, and so forth.
• Take steps to protect trade secrets and intellectual property.
• Elect how the LLC will be taxed — that is, like a C-Corp, S-Corp, or at the individual level.

See Practical Law’s LLC Operating Agreement Commentary, Forming and Organizing an LLC (Delaware),* and the Start-Up Company Offer Letters, Employment Agreement, and Equity Compensation tool kit.

Additional LLC resources for startups and small businesses

Starting a small business or startup is an exciting chapter in anyone’s life. An LLC is an easy and effective way to get a business started without the formalities of a corporation but with the benefits of limited liability. Most states make creating an LLC a fairly straight forward and inexpensive process.

Explore the LLC resources provided in this article, and many more, through our legal research tool for small businesses, Practical Law. There you’ll find the necessary templates, checklists, tool kits, and practice notes to make creating the LLC a cinch, and something in-house counsel or any small business owner can do without engaging an outside counsel. Now, if you’ll excuse me, I have a small business to form!

Sterling Miller, CEO & Senior Counsel, HILGERS GRABEN PLLC

Sterling Miller is a three-time general counsel who spent almost 25 years in house. He has published four books and writes the award-winning legal blog, Ten Things You Need to Know as In-House Counsel. Sterling is a frequent contributor to Thomson Reuters as well as a sought-after speaker. He regularly consults with legal departments and coaches in-house lawyers. Sterling received his J.D. from Washington University in St. Louis.