Forming an LLC for a Franchise

Should I form an LLC for my franchise?

If you’re considering becoming a franchise owner, you might be wondering whether forming a limited liability company (LLC) is the right choice for your business venture. In this guide, we’ll explore the key considerations and benefits of forming an LLC for a franchise.

Forming an LLC for your franchise can offer several advantages that provide protection and flexibility to your business operations. One of the primary benefits of starting an LLC is the limited liability protection it provides. An LLC also enhances professionalism and credibility in the eyes of your customers, franchisors, and even potential business partners. Last but not least, LLCs enjoy tax benefits like avoiding double taxation because they’re considered pass-through entities. They can also choose the tax status that works best for them.

In this guide, we’ll provide you with step-by-step instructions and valuable insights on how to form an LLC for your franchise. Whether you’re a first-time franchise owner or an experienced entrepreneur expanding your business portfolio, forming an LLC can be a crucial step toward building a successful and sustainable franchise business.

Can an LLC be a franchise?

Yes, an LLC can indeed be a franchise. While franchises are typically associated with specific business models and branding, the legal structure of the franchisee entity can vary. Many franchisees choose to operate under the legal structure of an LLC due to its flexibility, limited liability protection, and tax advantages.

Starting an LLC allows franchisees to separate their personal assets from the liabilities of the franchise business, providing an additional layer of protection in case of legal issues or financial challenges. This can be particularly beneficial in industries where there may be higher risks or liabilities involved. Additionally, operating as an LLC offers flexibility in how the business is taxed, allowing franchisees to choose the most advantageous tax treatment for their specific circumstances. Overall, choosing to structure a franchise as an LLC can provide franchisees with both legal protection and financial benefits, contributing to the long-term success and sustainability of the franchise business.

Why Starting an LLC for a Franchise is Important

Personal Asset Protection

The top reason to form an LLC for a franchise business is to gain access to the personal liability protection provided by this business structure. Whether you operate a restaurant in a popular fast-food chain or a retail convenience store with a wide variety of products, you need the limited personal liability protections that an LLC can provide.

With a franchise, it’s important to form an LLC before you ever sign your franchise agreement. This is because it’s vital to have personal asset protection before you start transacting business. If you don’t, a creditor could claim that they did business with your company when it was a sole proprietorship or general partnership, and the courts would likely grant them access to your personal assets.

As an example of how an LLC can limit personal liability, let’s say that a customer slips on a wet spot on your floor, falls over, and injures themselves. If you operate your franchise as a sole proprietorship or general partnership, your personal assets — like your house, car, or personal bank accounts — would be at risk if that customer decides to sue your business. In short, you’d carry personal liability for the business.

On the other hand, if you form an LLC for your franchise before you begin conducting business, and you operate and maintain that LLC in a compliant fashion, the scope of your customer’s lawsuit will be limited to your business assets. In other words, your assets will be protected by the business structure you’ve chosen.

Taxation

This is just the tip of the iceberg when it comes to the advantages of the LLC for a franchisee. Another important aspect is taxation. The LLC actually provides its owners with a selection of options regarding how they want the business to be taxed, which can save you a considerable amount of money compared to simply operating as an informal business entity.

Sole Proprietorship/General Partnership

Your franchise LLC can be taxed as a sole proprietorship (for single-member LLCs) or general partnership (for multi-member LLCs), which is the default option. When taxed like sole proprietorships or general partnerships, LLCs don’t pay taxes themselves. Instead, the profits are passed through the business entity and your owners pay taxes on that money when they file their own personal taxes.

C Corporation

You can also choose for your franchise to be taxed as a C corporation, although this option isn’t very popular because it subjects your business to what’s known as double taxation — meaning that your profits are taxed first on the corporate level and again on the personal level when they’re distributed to your owners.

S Corporation

The other option is S corporation taxation. There are quite a few limitations to electing S corp taxation, but most franchise businesses have no trouble meeting these requirements — your business can’t have more than 100 owners, they all must be either residents or citizens of the United States, and so on.

S corp taxation can help your franchise save money by reducing your self-employment tax burden. Instead of paying self-employment taxes (a 15.3% tax that includes the employer and employee portions of Medicare and Social Security) on all of your business income, you can pay yourself and your co-owners a reasonable salary for your roles and only pay self-employment tax on that portion of your income, while you can reinvest the rest of it into your business without paying this tax.

Compared to operating a sole proprietorship or general partnership franchise business, the S corp taxation model can save you quite a bit of cash that you can use to make improvements to your business, rather than writing a big check to Uncle Sam.

Enhanced Credibility and Name Uniqueness

Finally, an LLC structure can enhance the credibility of your franchise business venture. Informal business entities don’t have exclusive assumed business names and typically operate under the personal name(s) of their owner(s). For instance, if your name is Johnny Smith and you operate a franchise sole proprietorship, your company’s name is also “Johnny Smith.”

Of course, this issue is much less important with franchises, because the public perception of a franchise is typically more in line with the parent company than the individual franchisee. Still, it’s undeniable that your vendors and business clients will take you more seriously if you form a formal business structure.

With an LLC, you not only have the rights to exclusive use of a business name, but you will also have either the phrase “limited liability company” or the letters “LLC” in that business name. This provides your business with a jolt of respectability because vendors, partners, and clients respect the professionalism displayed by an LLC. Also, they typically feel more comfortable writing checks to a business entity rather than to an individual.

What is an LLC?

LLCs are formal legal entities that are typically taxed similarly to sole proprietorships and general partnerships, in that the owners include any company profits or losses into their personal returns — the LLC itself does not owe income taxes. An LLC may also elect to have a corporation’s tax structure, although this is not a very common option.There are similarities to corporations, too, especially when it comes to financial responsibilities. In an LLC, the owners (known as members) are not usually personally accountable for the financial status of the business. This means that if someone sues your LLC, your personal assets are usually not at risk. For more information see our LLC definition page.

How to Start a Franchise LLC

The formation process for LLCs varies depending on which state you’re forming one in, but in general, the process has some universal steps that need to be taken no matter what state your business is located in. If you want a comprehensive overview of all the steps required to form an LLC, check out our complete guide on the topic. The basic steps in the LLC formation process in any state are as follows:

1. Choose an LLC name

Coming up with the perfect name for your new LLC is an important step. You’ll need to choose a name that represents your company and describes what you do, and you’ll also have to make sure it isn’t already in use by checking your state’s business database.

2. Designate a registered agent

Your LLC’s registered agent (which can be an individual or a professional service) is responsible for receiving important document deliveries from the state — like service of process or annual report reminders — and forwarding them to you. The registered agent ensures that the state always has a reliable point of contact for your business.

3. File your formation documents with the state

The form used to create an LLC is usually called the Articles of Organization, although the name can vary (some states call it the Certificate of Formation or something similar). You’ll need to provide the state with some basic information about your business and its owners. In exchange, the state will formally create your LLC.

4. Acquire an EIN

The Employer Identification Number (EIN) is a federal tax ID number that essentially functions as a Social Security number for a business. The EIN allows your business to hire employees, pay taxes, apply for bank loans, and more. You can obtain an EIN from the Internal Revenue Service free of charge.

5. File a BOI Report

New in 2024, your franchise LLC is required to file a beneficial ownership information report, or BOI report. You’ll file this report with the Financial Crimes Enforcement Network, providing vital information about your LLC’s “beneficial owners.” Beneficial owners are people who control the LLC or get significant economic benefit from it. It’s crucial to file this report by the deadline to maintain compliance; failing to file means you won’t be operating your franchise LLC legally and you could face hefty legal and civil penalties.

6. Create an LLC operating agreement

Most states don’t require operating agreements, but every LLC should have one regardless. This is an internal document that outlines several key operational aspects of your LLC. The value of the operating agreement is how it can help prevent ownership disputes down the line by clearly explaining how the LLC will be run.

7. Create a financial infrastructure

You will need a business bank account for your LLC, and you’ll probably want a business credit card for work-related expenses, as well. It’s also a good idea to use accounting software like QuickBooks or even hire an accountant to handle your bookkeeping for you.

8. Handle taxes, licenses, and permits

Depending on your state, you may need a general business license to operate your LLC in compliance with state requirements. In most states, you will need to register your franchise with the state before conducting business. Don’t forget to check with your state to see if there are franchise or privilege taxes assessed on LLCs, and also see if your municipal and/or county government entities have any further licensing requirements.

9. Understand maintenance requirements (annual reports, franchise taxes, etc.)

Again, these requirements can vary by state, but most states require some sort of regular report to ensure that your LLC’s info is up to date in the state’s business database. Some states require reports each year, while others only require them biennially or not at all. No matter what your state requires, you’ll need to stay on top of it to keep your LLC in good standing.

Additional Resources for Starting a Franchise

1. Score.org Franchising Resources

Score.org provides franchise business owners with a wealth of information, from webinars to guides, blogs, virtual classes, and more. If you’re looking for advice on franchise agreements, financial considerations, or any other aspect of franchise ownership, you’ll likely find it with Score.org.

2. Free Management Library

Free Management Library offers resources for entrepreneurs in a wide variety of business types, and they have a great library of tools for franchising, as well. They have plenty of information about preparing to become a franchise owner, how to choose the right franchise, funding your franchise, and more.

3. American Association of Franchisees & Dealers

The mission of the American Association of Franchisees & Dealers (AAFD) is to “educate the public regarding fair franchise practices, quality franchise opportunities, and to expose the unethical practices that have too long existed in the franchising community.” The AAFD’s website has information on fairness initiatives, buying a franchise, and much more.

4. Franchising.com

Franchising.com markets itself as “your complete guide to buying a franchise opportunity,” and we’re not about to argue! Their site has a ton of info for franchise LLC owners, with sections on news and opportunities, and information about conferences and webinars.