Why do I need to create an LLC?
A recession might not seem like the best time to start a business, but as Paula recently wrote, a slowdown can provide you with the time and financial incentive to start that business you’ve been planning.
If you’re starting a new venture you should consider creating a limited liability company — an LLC.
Whether your new venture is selling wristbands announcing your new unemployment, presenting makeup tips on YouTube, or tattooing pets, there is potential liability in your new venture. While you should make every effort to deliver a quality service and satisfy your customers’ expectations, things can go wrong.
You might be daydreaming when tattooing Flufy’s name onto her, misspelling her name. Your customer is heartbroken. You offer to cross out the spelling error and try over. Your customer doesn’t appreciate your grand gesture and decides, instead, to sue you. This is every entrepreneur’s worst nightmare.
Without the protection of an LLC, your personal assets are on the line — your checking account, savings account, house, boat… — everything.
The purpose of an LLC is to limit the liability of the company to the assets of the company. Your personal assets are protected. LLC’s were introduced across the US during the 1990’s, to encourage individuals to create businesses without the worry of risking their life’s savings. Of course, if you commit an act of gross negligence or malice, you will be held personally liable, and you will not not have the benefit of limited liability.
It is important to identify which assets are associated with your new company. It is your responsibility to define which assets belong to the business and which assets are your personal property. Establish a separate business checking account, and use it for only business purposes. Do not mix in your personal money (no commingling of funds). Keep a record of what equipment was purchased with company funds and is used (preferably exclusively) for company business. Should a judge need to settle a dispute, you want it to be clear which assets belong to you personally (and are therefore off-limits).
Establishing an LLC is relatively easy. Unless you have a special situation, you won’t need a lawyer. Regulations vary by state, but the first stop is usually your state’s Secretary of State website. Chances are you can file the forms online. You must choose a name for your new venture that identifies it uniquely within the state — that is, it must be reasonably distinguishable from similar sounding businesses. The name must contain the phrase “Limited Liability Company”, or “LLC”, or similar. You can search the state’s registry of existing businesses and a thorough Google should suffice. You must choose a business structure — sole proprietorship or partnership (and that choice is a subject for another post). Note that the “C” in LLC is for “company”, not “corporation”. A corporation is, by definition, its own business entity, and cannot be an LLC. A corporation pays taxes and can own property, and its liability is already limited to the corporate assets. The fee for filing the LLC Certificate of Organization varies by state. Massachusetts is relatively high at $500; Indiana charges only $90. Once your LLC is created, there is usually an annual reporting requirement, and if you decide to close the business, you must file a notice of dissolution.
So good luck with your new venture, and think of the LLC as (relatively) cheap insurance.
Let me know if you’re thinking of creating an LLC and if you have any questions.
Image from tattoo-a-pet
By day, Helen engineers new materials to make computer chips cheaper, better, and faster. When the son goes down (pun intended), she writes about personal finance at Affine Financial Services.
My understanding, from our lawyer, is that you should have an LP “behind” your LLC. The LP has all of the assets, and the LLC is the store front. The LLC does all of the business and immediately passes income back to the LP. So, if the LLC is sued it has no assets, and you lose nothing. It’s VERY important to run as a business, that means proper accounting, insurance, and separation from your personal accounts. That means all business expenses and income flow thru business-only accounts; no co-mingling of funds. Failure to run your company as a business can easily lead to the “veil” being pierced, as well as IRS considerations. Talk to a lawyer and your accountant. Read as much as you can on the internet; a little time doing research now can make or break you.
Good luck!
Tim: Not clear what you mean by “LP.” I’m going to guess that you mean “limited partnership.” A limited partnership is a partnership in which there is (at least) one General Partner and one (or more) Limited Partner. A General Partner has an active role in running the business; a Limited Partner is not involved in the day-to-day operations. A good example would be someone who is only an investor.
Not sure what kind of business you’re running, but I don’t think it’s really necessary to create a holding company for a simple small business. If you create the LLC (as either a sole proprietorship or a partnership), keep the business assets separate and identifiable, and do an honest job to keep your customers satisfied, I think you’re going to be alright.
If you have a straightforward business, and your lawyer is recommending creating a partnership to hold the partnership, I think your lawyer may be trying to create some billable hours for himself.
Great post, Helen. What about a freelancer? Should they set up an LLC?
Thanks for the nudge. I’ve been meaning to restructure as an LLC for the protection. I had thought it more complicated and I’m happy to read that it probably isn’t.
Serena: Great question. If you think you could be sued, and you have any assets at all, I would recommend an LLC. If you write a book review, and the author or publisher doesn’t like it, they might sue. If you write on personal finance, and someone takes your advice, and it turns out poorly, they might sue.
There are lots of scenarios that even the best-intentioned entrepreneur can’t foresee. Creating an LLC is such an easy thing to do, I’d recommend it for almost anyone who is sticking their neck out by offering goods or services.
I’d be happy to help you get started, if you like. Contact me by email.