The Pros and Cons of Creating an LLC

Think about the last big decision you made. How did you navigate it? Hopefully, you didn’t leave it to a coin flip.

Rather, you probably laid out your options, weighed the pros and cons, and did some research. Well, now you have a potentially bigger decision to make, one that will have a lasting impact on your new business – whether to form a limited liability company (LLC).

There are quite a few advantages to forming an LLC, but it’s not all rainbows and sunshine. Depending on your situation, creating an LLC could be an exceedingly smart move, or it could be a poor choice. But how do you know if the pros outweigh the cons?

We’ve done the legwork for you by writing out a long list of advantages and disadvantages. All you have to do is read through it and see what sticks out. By the end, you won’t need a coin flip — you’ll have enough information to confidently decide if an LLC is right for your business.

What Is an LLC?

Entrepreneurs love the LLC as a business structure because it fills in the middle ground between the more casual approach of a sole proprietorship or general partnership and the formalities of a corporation.

Corporations have much more complex compliance requirements, whereas sole proprietorships and partnerships aren’t even considered to be separate legal entities from their owners. But LLCs fall nicely in between, providing structure and flexibility where each is necessary.For more information see our LLC definition page.

So what are the defining characteristics of an LLC that make this business type a better (or worse!) option than those other entities? Let’s find out!

Pros of Creating an LLC

1) Personal Asset Protection

This is the big one, the main reason why many entrepreneurs decide to start an LLC. Personal asset protection means that if your business is sued and the court rules against it, creditors cannot pursue personal possessions like your house, cars, and personal bank accounts.

Instead, they can only go after your business assets. In this way, your liability is limited, hence the name “limited liability company.” Running a sole proprietorship or general partnership puts your possessions at risk because they allow creditors to pursue anything you own.

2) Simple Formation and Maintenance

Forming a corporation is like piecing together a puzzle – there are a lot of moving parts and steps. By comparison, the limited liability company is relatively simple to form, and the ongoing compliance requirements aren’t complicated either.

An LLC’s formation paperwork is quick and painless. You’ll complete and submit an Articles of Organization form then, boom, your LLC is formed. Every state has specific Articles of Organization forms on their websites, so it’s really just a matter of filling in blanks and paying a fee. As for the maintenance requirements, many states require annual reports, but they’re mostly easy and just a way to update the state about any important changes to your company’s contact info.

3) Pass-Through Taxation Model

While an LLC owner can, technically, choose to have their business taxed like a C corporation or S corporation, the vast majority of LLCs stick with the default, which means they’re taxed like a partnership.

This means that business profits “pass through” the business entity and are claimed on the owners’ personal tax returns instead ― there is no business tax return at all. It helps LLCs avoid the double taxation that usually befalls corporations, where profits are first taxed on the corporate level, and then again on the individual level.

4) Flexible Management

Being able to customize your managerial structure can be a huge advantage as your business grows and evolves. The LLC gives you not only flexible management, but flexible ownership too.

How? First off, you can form either a single-member or multi-member LLC, and you can have as many members as you want. One? Five? 300? It’s all good. This flexibility makes it easy for an LLC to grow aggressively without having to alter its business structure. Unlike, for example, limited liability partnerships, which require multiple owners, or S corporations, which cannot exceed 100 owners.

But there’s more flexibility to go around. If your LLC members want authority over daily managerial tasks, by all means, they can take it. You will just designate your LLC as member-managed on your formation documents and operating agreement. Or, if they have bigger fish to fry, you can outsource those duties to specified managers, designating it as manager-managed.

This is a nice option because your LLC might initially be better-suited to member management, but down the road, after it’s increased in size, you might want to bring in some help.

5) Flexible Payouts

Rather than distributing your profits to shareholders like you would with a corporation, LLC owners get to decide how they want to allocate it. Maybe you want to split it equally. That works! But if certain members are more invested than others, you might want distributions to reflect that. With an LLC, either option is possible. Just make sure you draft a detailed outline of your distribution plan in your operating agreement, just so that there are no disputes later on.

Cons of Creating an LLC

1) Self-Employment Taxes

While an LLC doesn’t pay corporate income taxes, its owners will owe a bit more on their personal taxes. This is because the government does not consider limited liability company members to be employees of that LLC, but rather self-employed individuals.

This means that each member will need to pay self-employment taxes on their share of LLC profits. Self-employment taxes include both the employee and employer shares of Medicaid and social security, which comes to a rate of 15.3% This is, of course, in addition to your income taxes.

2) Formation and Maintenance Fees

While corporations usually have the highest formation and ongoing compliance fees, limited liability companies still have considerably higher expenses than sole proprietorships or general partnerships.

How much you’ll pay, however, depends on your state. Every state charges some sort of formation fee, which can range from less than $50 all the way up to several hundred dollars. On top of that, most states also have annual report fees which also vary widely depending on your state.

Be sure to check with your specific state’s government to know how much you should write into your LLC’s startup and annual budgets.

3) Paperwork and Record-Keeping

Ah, paperwork. Whether you’re starting a business, going to the doctor, getting married, or doing seemingly anything else, it’s impossible to avoid. Forming an LLC is no exception. Once again, limited liability companies might not require quite as much paperwork as corporations, but they certainly require more than sole proprietorships or general partnerships.

Your LLC should keep copies of its formation documents, annual reports, tax documents, an updated list of members and managers, and an operating agreement. Because sole proprietorships and general partnerships don’t need any of these documents, they have no responsibility to keep them. LLC record-keeping isn’t a ton of work, but it’s one more addition to your to-do list.

4) Can Be Uninviting to Investors

Limited liability companies certainly attract more investments and venture capital than sole proprietorships or general partnerships because many investors see them as more credible and reliable. However, LLCs aren’t nearly as attractive to venture capitalists as corporations.

This is because LLCs cannot issue stock, so the only way to attract investors is selling membership shares in exchange for investments, which isn’t nearly as common as investing in a corporation. So, if you anticipate your business needing investments during the startup phase or later on, there’s no guarantee that an LLC can deliver them.

Should I Hire Someone to Help Form My LLC?

If you’re not thrilled about the idea of forming your own limited liability company, there are other options. Of course, there’s a little give and take. You can outsource the LLC formation process to decrease the amount of paperwork on your plate, but it will increase your expenses.

Some entrepreneurs like to hire a lawyer or accountant to form their LLCs, which is a reliable option but also a very expensive one. Instead, we recommend using an online LLC formation service that can professionally form your new business for a fraction of what you’d pay a lawyer.

Conclusion

As a reminder, here are the essentials: LLC advantages include personal asset protection, simple formation and maintenance, pass-through taxation, flexible management, and flexible payouts. On the other hand, its disadvantages include self-employment taxes, formation and maintenance fees, paperwork and record-keeping, and the difficulty of attracting investors.

Now that you’ve seen both sides of the scale, all that’s left to do is to weigh your options. Choosing a business type is a complicated and personal decision. It’s important to consider the size of your company, your state of formation, and the nature of your business when choosing whether or not to form an LLC.

Because you’ve carefully considered both sides of the coin, you can be sure that, whether you choose to form an LLC or not, you’re taking the route that will best serve your business and propel it toward success.