Starting a new business can be an extraordinary stressful and fear-laden endeavor, and the pressure to pick the proper business form can only add to this pressure. In a previous post, I discussed some of the pitfalls entrepreneurs face when starting a business without properly planning with a business attorney. For the entrepreneur starting a business, however, the solution to the choice of entity dilemma is often quite simple.
Though not right for every situation, forming an LLC provides a simple, flexible option that offers many of the benefits of the corporate form without many of the stringent governance requirements and unfavorable tax treatments. While you should discuss your individual circumstances with a business attorney before deciding on any business form, every entrepreneur should at least have an understanding of the LLC form when starting a business. In this and a subsequent post, I will provide a basic overview of the limited liability company (LLC) form.
Forming an LLC
As I discussed in a previous post, without an overt action by the owner or owners when starting a business, the government will consider the business a sole proprietorship or general partnership respectively. Forming an LLC requires the intentional act of the business’s owner or owners, who must file Articles of Organization with Arkansas’s Secretary of State. There is a $45 filing fee associated with this with an additional annual franchise tax of $150 without regard to the income of the business—meaning an LLC bleeding red ink will pay the same annual franchise tax as a highly-profitable multi-million dollar business.
Forming an LLC when starting a business is something that you can do yourself—and in fact many self-help online legal services advertise packages to help you do just that—but the proper filing of documents is critical to securing limited personal liability. A small mistake could have potentially devastating consequences later, so it is critical that you have a thorough understanding of the formation process before you attempt to do it yourself. If you are concerned about the associated risks, you may want to work with a business attorney who can guide you through the process and ensure everything is in order.
What is Limited Liability?
Limited liability means that the members—that is, the owners—will not be held personally liable for the debts, obligations, or other liabilities of the business. Limited liability does not mean that the members cannot be held personally liable for their own actions after forming an LLC, but it does mean that they cannot be held liable for the actions of other members, employees, or the business itself.
So, for example, a member can be held personally liable if he or she injures a customer while negligently stocking shelves, but a member cannot be held personally liable if another member or an employee does so. A member’s liability is generally limited to his or her exposure in the business—that is, essentially, his or her investment—but nothing more.
This is not a benefit available in general partnerships or sole proprietorships. Under those business forms, the owners’ personal assets are available to satisfy the claims of creditors and court judgments. A business attorney should be able to provide additional explanation regarding the extent of limited liability forming an LLC provides.
Consequences of Improper Formation
As discussed above, careful compliance with applicable law is critical to ensuring that every member enjoys the benefits of forming an LLC. If you make a mistake in the formation process, a court may deem your business to be operating as a general partnership or sole proprietorship with the resulting personal liability for the business owners. Realization of such a mistake may not come innocuously but rather only when a court rules in a lawsuit against your business that you can be sued personally. Limited liability is probably the most significant benefit of forming an LLC—and a corporation, for that matter—and so protecting this benefit is critical from the beginning of starting a business. Starting a business is inherently risky but careful planning can mitigate a substantial aspect of this risk.
In part 2 of this blog post, I will provide a general overview of the governance and tax implications of forming an LLC.