Limited liability companies are the popular new choice for business start-ups. The “LLC" has only been in existence for roughly 26 years and there are some definite pros and cons.
A limited liability company is a creature of state law. Prior to the late 1970s, it had never been a choice for businesses because it didn’t exist. In the late 1970s, the State of Wyoming passed an act creating it. It took another ten years or so before other states caught on. Once they did, the mad rush was on to pass legislation allowing for the creation of LLCs in nearly all states. The world of business entities had been changed forever.
The LLC is a business entity designed to help small business. As a result, most of the positive reasons for using it are catered to such business. In a general view, the entity is heavily favored because it provides liability protection from lawsuit judgments and business debts just like a corporation. On the other hand, the entity does not carry the legal requirements for running it like a corporation. Few board meetings are required and the administration of minutes and such is extremely simple. For small businesses, this cannot be understated.
Another significant positive of the limited liability company has to do with taxes. The IRS made a landmark decision in the late 80s to allow the LLC to be taxed like a partnership. This means the business owners can elect to have the finances of the business pass through to their personal returns. Doing so avoids the double taxation situation corporations are often criticized for.
The LLC is a great vehicle for small businesses, but there are some important cons associated with it that you must understand. First and foremost is the lack of history in relation to the entity. While it is supposed to provide the protection of a corporation from liability, this has not entirely been flushed out in the courts. So far, the decisions seem to support the idea, but it will be another 20 years at least until we can all be sure. Courts have a history of interpreting laws differently than the legislature wrote them.
Another con is clearly the fact that an LLC cannot be taken public. If you start a business and it takes off, the company cannot be listed on any stock exchange for a basic reason. To trade stock on an exchange, there has to be…well, stock. A limited liability company does not have stock. Instead, the owners are called “members" and own membership interest like you would see in a partnership.
Finally, there are a certain number of states that limit the use of the limited liability company. States like California, for example, do not let professionals use the entity. Professionals can be defined surprisingly broadly. While doctors, lawyers and accounts seem obvious, certain states also will restrict real estate agents, consultants and other professions. Ironically, the states will usually approve the filing, so you don’t know there is a problem till someone sues you.
At the end of the day, an LLC is often a great vehicle for small businesses. Just make sure you understand the limits.
Richard A. Chapo is a San Diego business lawyer providing services for limited liability company formation in California .