What Does LLC Mean and How Do They Work?


Members (a.k.a. Owners) of Limited Liability Companies receive the limited liability protection of a Corporation while paying the taxes of a Partnership.

An LLC’s personal liability protection is what keeps your personal assets (house, car, personal bank accounts, investments, etc.) safe from business debts or lawsuits.

Taxes are paid through the Pass-Through Process with the standard setup, but there are options to upgrade your tax status.

Since LLCs are so flexible and simple to use, it’s no surprise that there are millions of active LLCs with new ones being created every day.

Basic LLC Info

Being the LLC Owner, you’re in the driver’s seat. You hold the wheel.

You’re in control.

You file taxes how you want.

You arrange the management how you want.

You decide how much and how often you want to get paid.

The LLC is the easiest, legally recognized business entity to operate.

Professionals and novices alike prefer LLCs because of the combination of simplicity and the authority they offer.

Your business success is limited by your decisions and the actions you take.

Another huge reason why someone chooses an LLC over any other entity is the legal and financial protection it offers. Not to mention all of the tax benefits that come with operating a Disregarded Entity.

LLCs may not have as much protection as an S- or a C- Corp entity for example, but it’s sure better than no protection at all. Plus, it’s a lot simpler than these other business types. You won’t lose the option of becoming a Corporation in the future, but in the meantime, you’re probably better off starting as an LLC.

How Does an LLC Protect You?

LLCs give owners personal liability protection. This is the whole reason why they are called Limited Liability Companies in the first place.

As the Owner, you won’t be personally held responsible for your LLCs debts or legal disputes.

You still have to be careful, this protection is limited after all.

These protections are only effective so long as you keep your business’s finances separate from your personal earnings.

You will, however, be personally accountable if you are the direct cause of your LLCs failure or if you’re not correctly separating business and personal finances.

The technical terms for these are Undercapitalizing and Piercing the Corporate Veil.

Undercapitalization is when you underfund the company, ruining its ability to pay back debts. Piercing the Veil is when you fail to distinguish between business and personal.

If you’ve done either of these, your limited liability protection may be waived. Should this happen, you’d now be personally responsible to cover your business’s debts and legal disputes.

This means your private assets and investments are made vulnerable. In other words, the lawyers and courts can come and take your personal belongings.

This protection is great because if your LLC gets hit with a lawsuit, goes bankrupt (in some states, this only applies to MMLLCs), or something similar, you won’t be personally liable to pay what is owed. Instead, the LLC itself is held accountable.

The entity is liable, not you.

This is all the result of your personal assets being kept separate from your business (and by following the law).

Personal assets include things like your real estate, vehicles, investments, and private accounts.

DISCLAIMER: “Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making any binding decisions when it comes to starting, operating, and growing your business. External resources should be used independently of “Business Initiative”. It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.

LLC Structure

Use an LLC to suit your needs.

Entrepreneurs love LLCs since you can do so many different things with them.

Before you file for your very own LLC you have to figure out which variation is best for you.

Here, we will only briefly describe the case of default LLCs.

The standard LLC structure offers a massive amount of freedom and flexibility when it comes to owning and operating your business. This is all just with the regular setup.

That being said, there can still be a lot of variance between one company and another. Especially when you consider the state-to-state differences in LLC regulation.

To illustrate their versatility, let’s say you’ve already bought into the idea of getting an LLC,

As an LLC Owner, you can organize it as a Benefit Corporation, if you so desired. You could even set your LLC up to get taxed as a Corporation.

Believe it or not, you can do both at the same time:

Having the structure and operation of a B-Corp and the taxation of a Corporation.

The LLC you’ll choose depends on your business’s unique needs. How you structure your business determines your taxes, your level of legal and financial protection, and how complicated the registration process will be.

LLCs can be owned by one Owner (Single Member LLC) or multiple owners (Multi-Member LLC). Funny enough, the Members don’t even have to be people. Members can be other businesses or entities altogether.

One more interesting thing about LLCs:

There is no restriction to the number of members you can have.

LLCs offer a wide range of management options. You can do anything from hiring third-party managers to managing the whole LLC by yourself. The Management system you choose will fall into one of two categories:

  1. Internal Management

  2. External Management

If you want your LLC managed from the inside, you or a fellow Owner (Member) oversees operations. This gives you direct say over how your LLC runs.

When you’re in charge, you won’t have to go through anybody else to get something done or change something in the protocol. This is a great way to start and build your business because you have more direct control.

Since LLCs are so flexible, you can also choose to hire outside help as time goes on. Hopefully, as you expand your company and the elements of your LLC begin to fall into place, you’ll need a few extra pairs of hands.

If this is the case, you can hire outside managers for your LLC. This option puts more responsibility on someone who specializes in management.

This is usually done through a third-party management service focusing on optimization and efficiency. But, you also have the option of hiring a private expert to manage your LLC.

Articles of Organization and Operation Agreement

Other parts of the structure you should consider before you go all-in on an LLC are the Articles of Organization and an Operation Agreement.

Founders must gather the necessary information for the Articles of Organization and put a plan into place with an Operation Agreement. The Articles of Organization are different from an Operation Agreement.

Operation Agreements cover the more detailed, finer inner workings of your LLC. Articles of Oganization cover the main points of information necessary for registering your LLC.

For your Articles of Organization, you’ll need the following:

  • Full legal names of all Members and any managers you expect to hire.

  • The name and address of your LLC’s registered agent who will receive the required paperwork and forms from the government. This will be your point of contact to your State.

  • The unique name of your LLC and the address of its main location/headquarters.

The Articles of Organization identify your LLC’s focus and general structure. This document doesn’t require full Member approval because it is the LLC itself.

The Operation Agreement is a sort of contract outlining how your business is structured and how finances are managed. It covers your LLC’s more specific details and procedures.

The Operation Agreement requires approval from All Members because it deals with how and when members are paid among other specifics.

You must submit Articles of Organization, but an Operation Agreement is optional (for most states).

Whether or not you write out an explicit Operation Agreement, you do need a plan of action. It is through following this plan, and the relevant government regulations that you receive the complete liability protections offered by LLCs.

LLC Voting Rights

The influence a Member has over the decision-making process is typically relative to how much they invested in the business.

As an example, you and a buddy have an awesome idea for an LLC. All that’s needed is a source of funding to kick things off.

Luckily, you both have a wealthy friend who wants to see you all succeed. You and your friend decide to bring the third friend (rich guy) on board.

The three of you collectively decide that since he is taking on all the risk to see you and your buddy’s dreams come true, he gets 51% ownership while you and your friend each receive 24.5% ownership.

Based on our earlier explanation, your financier has over twice as much influence in your business’s decisions as you or your friend do. This would mean he doesn’t need you and your friend to agree with him for him to do something.

They say “money talks” for more reasons than one.

This is not an optimal scenario, but it might not be such a bad idea since he probably has some clue as to what he’s doing. After all, he somehow got rich in the first place.

If each member’s strength in the decision-making process isn’t clearly laid out in your Operation Agreement, you will have to abide by the LLC voting rights outlined by your state.

How Do Owners Get Paid?

Members choose the payout process of the LLC.

There are two ways the payments can happen. There are other special setups but the benefits of these are only worthwhile once your LLC is bringing in substantial profits on a regular basis.

The two options you are likely to choose from are:

  1. Owners Draws

  2. Unique Payment Plan

Draws are taken proportionally to each Members’ initial investment in the LLC. The greater a member’s percentage of company ownership, the more that member is paid.

The other way is by coming up with a Unique Payment Plan for LLC Members. This can be as specific and complicated as you want to make it.

Spoiler alert, most people just go with Members Draws based on ownership. This happens to be the default payout process for LLCs in most states.

Whichever way you decide to do it, the tax submission process is streamlined. The Feds make it extremely easy for business owners to give them their cut of your profits.

The classic way for default LLCs to be taxed is through the Pass-Through Process. The details of this method are covered in a separate article.

Registering an LLC

If everything you’ve read until now makes sense, creating your very own LLC is well within your capabilities.

It should go without saying, but when you submit your documents, make sure everything is correct. This is the only way to secure your limited liability protection.

Complete the necessary paperwork and LLC registration forms and file them with your State (or County, depending on your local laws).

When you come up with the best way to run your company and set it up, write it all out as an Operating Agreement. You can see Operational Agreements as a way of documenting your plan of action and outlining the various details of your LLC.

One of the first steps you’ll take in registering your LLC:

Apply for a Federal Tax ID Number, commonly known as an Employee Identification Number (EIN).

You’ll need this to pay taxes.

Before getting too deep into things, speak with business professionals, lawyers, tax advisors, etc.

They know the laws.

They know what’s in your business’s best interest (assuming you consult the right people). Plus, they know the relevant loopholes and tricks you can use to your advantage.

LLCs Compared to Other Entities

The following comparisons are in order of least to most complicated.

- LLC vs Sole Proprietorship

SPs don’t offer any liability protection. LLCs do offer personal liability protection, hence the name: Limited Liability Company.

Sole Proprietorships are businesses owned and operated by one “sole” individual. With an LLC you have the option of having multiple Members who own the company. Compare their pros and cons here.

- LLC vs Partnership

A Partnership is a business run by a pair of owners, also known as Parters. There is no limit to the number of Members or Owners of an LLC.

With LLCs, you have the added option of ownership by other organizations or entities instead of just people.

- LLC vs S-Corp

The term S-Corporation (S-Corp) merely refers to a tax classification that an LLC can file as. LLCs, on the other hand, are business entities themselves.

S-Corps are just a specialized variant of an LLC that undergoes a different tax process.

- LLC vs Full-On Corporation

Corporations have a complicated registration process relative to an LLC. LLCs don’t need to file as much paperwork.

LLCs also don’t require regular maintenance and record-keeping. Whereas these are necessary to continue operating as a Corporation.

Corporations are a better option for established companies. LLCs are great for starting and building.

As an LLC you have the added opportunity of changing your tax status to a Corporation (while remaining an LLC) once your business has become more established.

In Conclusion…

  • LLCs are the most popular business structure registered today.
  • The LLC is easy to manage because it is the simplest, most adaptable business entity.
  • The Pass-Through Process of taxation for default LLCs is much easier than other business types.
  • LLCs provide numerous tax benefits, one of which is avoiding Doube Taxation.
  • On top of all of this, you will be able to protect ya neck in the unfortunate event things take a turn for the worse.

All of this and more come when you run your business with an LLC.

Sure, LLCs are a great way to begin your entrepreneurial pursuits but you should measure twice before you cut to ensure you’re doing what is right for you, your business, and your goals.

It could never be easier with so many companies providing services to help entrepreneurs set up LLCs.

We wish much success for you and your business.

DISCLAIMER:

“Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making any binding decisions when it comes to starting, operating, and growing your business. External resources should be used independently of “Business Initiative”. It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.