10 Good Reasons to Form an LLC
Limited Liability Companies (LLCs) are flexible — you can use them for practically any purpose — and they offer more benefits than any other entity type. They have a favorable pass-through tax status, and with the dual liability protection that LLCs offer, corporations and limited partnerships can’t compare. Following are some good reasons to form an LLC.
To customize your small business
LLCs are great for small businesses because they’re adaptable to all situations. No matter whether you have 100 silent investors or are a two-person small-business operation, the LLC is so flexible that you can pretty much write the operating agreement to suit your needs; you can make your own rules and tailor your entity to suit the intricacies of your business.
With a corporation, you’re limited to stiff corporate formalities and the weighty, unbending infrastructure of shareholders, directors, and officers.
To protect real estate assets
The LLC is a perfect entity for real estate holdings — you just can’t beat it! One advantage is that an LLC has dual liability protection that shields your investments from the frivolous lawsuits filed against people like you every day. So if you rear-end someone in a parking lot and he sues you personally, he can’t seize and liquidate your investment properties to settle the claim if they’re held in an LLC.
To shield intellectual property
Unless you have a bunch of important patents, placing all your intellectual property in separate LLCs is overkill. You don’t want your intellectual property to operate with the public; that’s your operating company’s job. So how do you link your intellectual property in your LLC to your operating company?
Have the LLC that holds your intellectual property lease the patents, trademarks, or copyrights to the operating company for its use. You need to sign paperwork and transfer money to make the arrangement official. After all, if it doesn’t look legit, then there’s no point in doing it in the first place.
To raise seed capital for your business
The LLC is quickly becoming the entity of choice for raising seed or angel capital — early-stage investments under $500,000 or so. Whereas venture capital firms generally prefer to invest in corporations because they’re most familiar with them, smaller investors love limited liability companies.
The partnership pass-through taxation allows investors to deduct their contributions, and if your little start-up doesn’t turn a profit, they can use the losses to offset other income. That is a huge benefit to investors. If the business fails, they may not get their investment back, but they’ll still get a nice deduction.
To plan your estate
Don’t overlook the value of the LLC when you plan your estate. Although it’s a simple entity in comparison to some of the über-complex trusts that your attorney may recommend, the LLC provides powerful asset protection. LLCs protect you not only from creditors, but also from probate lawyers and court costs.
They allow you to avoid probate altogether, which means that your estate isn’t subject to the nickel-and-diming that probate attorneys siphon from estates as the court divvies up assets.
To do a short-term project
LLCs were made for short-term projects. When these entities were first introduced, they were never supposed to live forever like corporations do. That’s why, when you create your articles of incorporation, you state a specific dissolution date or term, the number of years that the LLC is to be in existence.
Although most states allow you to extend the LLC beyond this term with a simple vote of the members, this scheduled termination of the company is convenient for short-term projects such as real estate development and film financing.
To segregate assets
Segregating assets is vital in business. By segregating your business assets into individual LLCs, you put them out of the reach of your company’s creditors or people who may want to sue you.
A lot of people incorrectly think that if they’re operating as a corporation or an LLC, then their assets are safe, but that’s not necessarily true. If you’re like most entrepreneurs, your business is your biggest asset. If you lose the ability to operate, you’re doomed.
Your business may be protected from your personal creditors, and you may be protected from your business’s creditors; however, what protects your business from its own creditors? If your LLC gets sued, everything inside it can be seized and liquidated. Even worse, the courts can put a lien on your company and then do an asset freeze, which means that you have zero access to your operating capital — you can’t write checks or receive funds from clients.
The best way to fully protect your assets (and your access to them) is to keep no assets in the operating company. Instead, the company uses leased assets. In this case, you own the leasing companies (or your business does). Each asset is put into a different LLC, and each LLC then leases these assets back to the operating company.
To minimize your tax burden
When you first go into business, chances are your company won’t be profitable right away. Building up a business takes time, and in the first year or two, you probably will incur thousands of dollars in losses. A lot of entrepreneurs, eager to soften the financial blow of the startup phase, decide to form an LLC.
With an LLC and its default partnership taxation, the losses of the business flow through to the members so that they can use them as deductions for other income.
To change the profit distributions
An LLC’s profits can be paid out disproportionately to the actual ownership percentages, so you and your partners can set up the company so that you receive all the profits and losses — even if you own only 10 percent of the company.
Why would you want to do that? Well, a common reason for changing the distributions is to provide an extra incentive for investors. For example, if one investor contributes all the capital, he gets 50 percent of the company.
However, the profit distributions can be varied so that he receives 100 percent of the profits until his investment has been paid back (plus 10 percent in some cases). Then the profit distributions return to normal, and the profit is split equitably among the members.
To protect your personal assets
When you spend your entire life saving for retirement, your children’s education, or even that second home you’ve long dreamed about, nothing is more crippling than losing it all in a lawsuit. If you’re like most people, you currently hold all your personal assets in your own name: your savings account, your cars, and your mutual funds, stocks, and bonds.
Start by forming an LLC. Better yet, form a series of LLCs. Then contribute all your personal assets to those LLCs and make sure that they’re isolated from one another. That way, if a debt arises pertaining to one of your assets, then all your other assets are safe.