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LLCs are the favorite choice for small local business entities with one to three owners who do not plan to grow their business significantly and do not expect to raise significant amounts of capital. As the number of owners grows, the corporation becomes a more attractive choice as a business form.
The LLC changed all that. The LLC offers the liability protection benefits of the corporation without the corporation’s burdensome formalities. It is this simplicity that has made the LLC an instantly popular business form for smaller companies.
Another attractive feature of LLCs is their flexibility. An LLC can elect to be taxed either as a partnership or as a corporation. An LLC can be managed like a partnership (a member-managed LLC) or like a corporation (a manager-managed LLC). An LLC can create a board of directors and have a president and officers just like a corporation. An LLC can choose to have periodic meetings of its members or choose to ignore such formalities altogether.
POTENTIAL DISADVANTAGES OF THE LIMITED LIABILITY COMPANY
The LLC has some disadvantages that will make it an undesirable business form for some purposes. The LLC is a new business form and courts have not yet developed a body of legal precedent governing it. Thus, LLC owners and professionals may face operating questions and issues for which they have little or no legal guidance. That said, this concern lessens as the states develop a reliable body of law concerning LLCs and is of no concern at all for very small companies.
Furthermore, for business owners who wish to pursue venture capital, accumulate a large number of shareholders, and/or eventually pursue an initial public offering, the LLC is not an appropriate alternative to a corporation. Venture capitalists and angel investors tend to shy away from investing in LLCs. Most large, publicly held companies are corporations, not LLCs.
What should the owners of an LLC do if their company grows so much that an LLC is no longer the appropriate business form? The answer is simple: it is possible to convert an LLC into a corporation. Thus, some small companies begin life as LLCs and then outgrow the LLC form, so the owners transfer the assets of their LLC to a corporation they form. Thereby, the LLC is converted to a corporation. Furthermore, as one might imagine, it is also possible to convert a corporation into an LLC or to convert nearly any business form into any other. It is also possible to reorganize a business in another state by transferring the assets of a business into a newly chartered entity. Converting business forms requires some sophisticated legal and tax analysis and it should not be attempted without the services of a qualified attorney and accountant
The cost of setting up an LLC is roughly equivalent to setting up a corporation. The secretary of state’s fees for filing articles of organization and for filing annual reports are often the same for both LLCs and corporations. Organizers who wish to seek help with organizing an LLC through an LLC formation service or through an attorney will find the fees to be roughly the same.
Advantages and Disadvantages of the Limited Liability Company
Advantages of the limited liability company:
• LLCs do not require annual meetings and require fewer ongoing formalities.
• LLC owners are protected from personal liability for company debts and obligations.
• LLCs enjoy partnership-style, pass-through taxation, which is favorable to many small businesses.
Disadvantages of the limited liability company:
• LLCs do not have a reliable body of legal precedent to guide owners and managers, although LLC law is becoming more reliable as time passes.
• An LLC is not an appropriate vehicle for businesses seeking to eventually become public or seeking to raise money in the capital markets.
• LLCs are more expensive to set up than partnerships.
• LLCs must usually make periodic filings with the state and pay annual fees.
• Some states do not allow the organization of LLCs for certain professional vocations.
IS AN LLC A TYPE OF CORPORATION?
An interesting question I often hear is the following: “Is an LLC a type of corporation?” The answer is “No,” but LLCs bear some resemblance to corporations. First of all, a corporation is a state-chartered entity that is authorized by a state’s corporation law. LLCs are authorized to be formed by a different set of statutes, never by the same state law that authorizes the formation of a corporation. LLCs have their own separate statutes in all 50 states. Thus, in the eyes of the law, an LLC is a separate type of business organization and should not be confused with a corporation, despite many similarities between the two.
HOW LLCS ARE FORMED
LLCs are formed much like corporations. Both LLCs and corporations are chartered entities. This means that, unlike some types of partnerships that can be created without state registration, LLCs and corporations can be created only by filing a charter document in the state of organization or incorporation. An LLC’s charter document is called its articles of organization—a name obviously borrowed from the corporation’s articles of organization.
Articles of organization for LLCs are very similar to articles of organization for corporations. For example, both of them state the entity’s name, require the appointment of a “resident agent” (more on this below), and usually require a statement of purpose.
HOW LLCS ARE GOVERNED
LLCs can be governed in various ways; they are the most flexible types of business organizations in this respect.
Corporations, by statute, are required to be governed by representative management. In other words, corporations are governed by a board of directors who are elected by shareholders. (Close corporations are a partial exception to the rule of representative governance, but close corporation status is not available in all states and is hopelessly complicated.) A corporation’s directors may in turn delegate some of their powers and responsibilities to officers that they appoint.
General partnerships, on the other hand, are governed by their owners. The power and authority to operate and govern a general partnership fall upon the owners directly, without any representative management. The owners of a general partnership vote in proportion to their ownership interests.
LLCs can be governed either by direct management or by representative management. LLCs must always make an election to be governed by their owners (member-managed LLCs) or by an elected body or group of managers (manager-managed LLCs). A member-managed LLC is governed by its owners (members) equally, just like a general partnership. A manager-managed LLC is governed by one or more appointed managers. These managers need not be members of the LLC. A manager-managed LLC is managed much like a corporation, by an appointed body of persons other than the owners. The managers who undertake the governing responsibilities of an LLC can form a board or a committee.
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