Often, when working with my consulting and business legal clients, I am asked if having a LLC makes your business “legitimate.” Last week, again a student from an entrepreneurship course I teach asked “Can you have a real business without it being a LLC?”
So just what is a LLC?
A limited liability company, more often referred to as a LLC, is one of many types of business structures you can choose when forming a business entity. For most small business owners, especially microbusiness owners, meaning those who employ 10 or less, who are starting a new business, most commonly choose to start a LLC There are many factors to consider when choosing how to structure your new business. LLCs, especially in Kentucky, are fairly simple to form and get started.
A limited liability company is an independent legal entity that exists separately from the people who own, control and manage it.
The business does not end or dissolve just because its owner or owners die. This is because the LLC is considered a separate entity from its owners, just as a child is a separate person from its parents. Because the company can enter into contracts, pay taxes, transact business and more, just like a child can for his or her parents, the company can create liability for its owners. So just as if your child breaks the neighbors window, the neighbor may come after the parent as well to repay. So, when a business creates liability, this just simply means the company can be sued and usually when this happens so will the owner.
However, a benefit the owner has in forming a LLC, this structure can offer limited personal liability to its owners.
Another benefit to starting a LLC is that while it offers some liability protection for its owners and their personal assets, a limited liability corporation does not require as many filings, reporting or other formalities as a corporation. LLC owners are not required to hold regular stockholder or management meetings, and there are no requirements to comply with other formalities required by corporations and other structure types.
Are There Reasons Not to Form a LLC?
You can start a business at any moment, even if you never incorporate or file anything to start a formal structured entity. For tax and legal purposes, you are in business if you sell or trade goods and services for payment. Doing so without a formal entity is simply known as “sole proprietorship."
And there are good reasons to be a sole proprietor and not start a LLC, which include:
· Another entity type works better for your goals and business plan.
· The cost to do so outweighs the benefit or the revenue generates is too low.
· You are still trying to validate the viability of your business idea or venture.
· You only intend for your business to a be a side hustle or a hobby you do when you want or not long-term.
· You do not make much or intend to earn much money from the business (for example, make under $1000 for the year).
· The type of business is not very risky so little or no liability to be concerned with exists.
· It is just you and you do not have any employees or partners.
· You do not intend to take out a loan or need any business financing.
Some Advice for The Sole Proprietor
This unincorporated entity still requires the sole proprietor to adhere to good business practices. If you are in business but do not want to formalize your business as a LLC or other entity type, I suggest the following:
· Keep very good records of what you spend on your business, what you make and how you reimburse yourself for business expenses.
· Keep your business and personal finances completely separate. You can open a business account or just maintain a separate personal account where you keep all of your business income and pay your business expenses from it.
· Keep an inventory of each transaction and customers in a designated spreadsheet, software or system.
· Be sure to file your income and expenses on your tax returns.
· Once you have made a significant amount (and preferably prior to your first tax return as a business owner) consider contacting an attorney or an accountant to determine if this structure works for you.
Remaining a sole proprietor is quite fine.
However, keep in mind that you may decide to form a LLC later. Just in case, keeping your business separate will be a requirement for this and a good habit to have for any business owner. This allows you to take full advantage of tax write-offs and deductions, securing outside funding and loans and more.
My best advice to any business owner, existing or aspiring, is to talk to a professional to see which structure makes the most sense for you and do so every 2 years or so to make sure your business is in the best position possibly to protect you, maximize profitability and minimize tax liability.
Nichole T. Compton is an attorney, entrepreneur and consultant. She owns Nichole T. Compton & Associates, PLLC, Louisville’s Premier Black Law Firm, and serves Louisville and Kentuckiana businesses and families in areas of law, mainly including business, personal injury, estate planning, credit and bankruptcy. She also owns Biz.Law.Life! and Nichole Compton LLC, in which she offers business formation services, business contracts and Biz.Law. Coach-on-Call services.
For years, Nichole has taught law, business and entrepreneurship for a few universities and offers private individual and group CLE and relevant workshop sessions.