7 Reasons the LLC Is the Most Popular Entity for Entrepreneurs Starting a Business
It was only about 25 years ago that the LLC became officially recognized in all 50 states, but today it is the most popular entity type for entrepreneurs looking to launch a new business. Thousands of LLCs are now created each day in America, as more and more people look to this business type for its balanced, flexible structure.
That said, the LLC won’t be ideal for every entrepreneur. Some people are probably better off starting corporations, while some might be able to get by with an informal business structure like a sole proprietorship. How do you decide which entity is the right option for you?
I’m a big fan of the LLC for entrepreneurship, and I do in fact own LLCs of my own. In this article, I’ll walk you through the top reasons for the LLC’s popularity and help you determine if it’s the right choice for your new business venture.
In my opinion, protecting your personal assets is the best reason to form an LLC instead of operating a sole proprietorship or general partnership. How does asset protection (also commonly referred to as the corporate veil) work? Let’s say that you operate a brick-and-mortar retail store and a customer has a slip-and-fall accident. If that customer sues your business, the LLC will shield your personal assets from the lawsuit — only the assets owned by your business would be at risk, while your house, car, personal bank accounts, investments, etc. are protected.
It’s important to note that corporations also provide this same form of asset protection to their owners, so this isn’t exactly a unique advantage of the LLC. Let’s dig a bit deeper into this list and see where the LLC gains its advantages over the corporation.
Compared to corporations, LLCs are much more structurally customizable. Corporations have rigid structures that require you to follow some strict guidelines regarding ownership meetings, appointing directors and officers, shareholder responsibilities, and more. However, with an LLC, you can make changes to the way your company is managed, swap in new owners, make amendments to your official formation documents, and more anytime you want to.
Why does this matter? As your business grows and expands, it’s likely that you’ll need to make some structural changes. Maybe you’ll need to hire a manager to oversee your LLC’s operations. Perhaps you’ll want to bring in a new owner to share in the responsibilities. Regardless of the reasoning, there are quite a few situations in which a growing company would want to shift some structural elements, and that’s infinitely easier to do with an LLC than a corporation.
Cheap and Easy Formation Process
Another concrete advantage of the LLC compared to the corporation is how inexpensive and simple the setup process is for an LLC. This is another area where the LLC dispenses with many of the formalities and busywork involved with corporations. The paperwork required to form an LLC — usually called the Articles of Organization, although some states use other names like the Certificate of Formation — is rather straightforward in most states, as you only need to provide some basic information about your company to get your business off the ground.
Meanwhile, corporate formation documents are typically more in-depth than their LLC counterparts, but that’s only the tip of the iceberg. Corporations often have much higher formation fees than LLCs, and there are more formal requirements as well. For instance, corporation owners need to indicate how many shares of stock they will distribute, what class of stock they will issue, detailed information about each owner, and more.
Choose Your Taxation Model
LLCs also have several options when it comes to taxation, which is a unique advantage compared to other business structures. The LLC essentially lets you choose which other entity’s taxation model you want to follow. The default option is to tax the LLC like it’s a general partnership or sole proprietorship. These taxation models are known as “pass-through” tax systems, in which the LLC itself does not pay taxes. Instead, its profits and/or losses pass through the business structure to the LLC’s owners, who then claim that money on their own personal taxes.
LLCs can also elect corporation-style taxes. C corporation taxes cost the business 21% in federal income taxes, plus whatever your state charges (between 0% and 11.5%). In addition, your owners would be required to pay taxes on their distributions, a process that’s often referred to as “double taxation” because the same money is taxed two times. While C corporation taxation has its downsides, it could be a good choice if your owners are wealthy individuals who can save some money by avoiding paying personal income taxes on all of your LLC’s income.
S corporation taxation is another option, and this model functions as a sort of middle ground between general partnership or sole proprietorship taxes and those of a C corporation. Like the general partnership and sole proprietorship, S corp taxation is a pass-through model. The biggest difference between the taxation of S corps and informal business entities is that S corp taxation allows your LLC to avoid some of the self-employment tax burdens of a general partnership or sole proprietorship.
If you choose to follow the taxation model of these informal entities, your LLC’s members will need to pay the 15.3% self-employment tax on all income. With the S corp model, you can pay your owners a reasonable salary for their positions, categorizing them as employees and avoiding some of the self-employment tax responsibility. However, not all LLCs qualify for S corporation taxes, so you only have this option if you meet the criteria (your LLC must have less than 100 owners, they must all be based in the U.S., etc.).
Options for Income Distribution
In a corporation, income distribution is quite strict. The amount of money each shareholder receives is directly tied to how much of the company they own. In an LLC, you can distribute your profits however you want to. You can split the money evenly as a corporation would. You can distribute it disproportionately to reflect different owners’ levels of involvement in your company. If you really want to, you can give it all to one person!
For many LLC owners, you’ll simply end up distributing your profits much like a corporation would. But it sure is nice to have the option to split them up any way you’d like.
Credibility and Exclusive Naming Rights
We’ve mostly focused on the LLC’s advantages over the corporation so far. Other than personal asset protection, what other advantages does the LLC have compared to informal business entities? If you own a sole proprietorship or general partnership, your business name is, by default, the same as your personal name. For instance, if your name is Tom Smith and you own a sole proprietorship, your company’s name is also “Tom Smith.”
In this scenario, you could always register a DBA (doing business as) name, which allows you to use an assumed business name. However, most states provide no exclusivity for DBA names, meaning that if another entrepreneur likes your DBA name, they can simply claim it as their own and you can’t do anything about it. With an LLC, you won’t have this concern. Every LLC receives the exclusive rights to use its name in its state of formation, and no one can use your name without your consent.
In addition, LLCs get to include the phrase “limited liability company” or the letters “LLC” in their business names. This provides a level of respectability and credibility to your business venture, as your customers know that you’re taking your company seriously.
Ability to Raise Capital
This category represents a slight disadvantage for LLCs compared to corporations, but a big advantage compared to informal entities. LLCs cannot issue stock, which limits their ability to fundraise compared to corporations. However, an LLC can always add an owner if it needs an infusion of capital, as the new owner brings with them new funding.
As long as you don’t mind giving up some of your responsibilities to accommodate a new member of your ownership group, LLCs can add new members to raise capital anytime they want to.
As you can see, the LLC has many advantages over other common business entities. Compared to informal entities like sole proprietorships and general partnerships, the LLC’s personal asset protection, credibility, and ability to raise capital are massive advantages.
Compared to corporations, the LLC’s flexibility, ease of setup, and income distribution models give the LLC an edge. And the options for taxation are an advantage for the LLC compared to all of these other entities.
Whether the LLC is the right business entity for your new company is a question you’ll need to consider on your own. But I hope that learning about these seven reasons the LLC is the most popular entity for entrepreneurs gave you the information you need to make an educated decision!
This article has been published in accordance with Socialnomics’ disclosure policy.
About Aaron Franklin
Frustrated by all the options and aggressive online sales tactics, I created BestLLCServices.com to cut the clutter and bring clarity to entrepreneurs starting an LLC. Our focus is on reviewing and comparing the top LLC formation services while also crafting free resources that help you start a business. We sincerely believe finding the right service and free information should be a simple process so you can get started with minimal friction.