One of the topics that clients at the Kansas SBDC frequently come to us for help with is whether they should form an LLC and, if so, how to go about it. While, in some cases, we recommend that clients also confer with an attorney and/or accountant, we can help with some basic information.
LLC stands for limited liability company (not limited liability corporation). It is a popular business structure because it can combine the advantages of a sole proprietorship or partnership for purposes of taxation with the advantages of a corporation for issues of personal liability protection. A limited liability company must use the words Limited Liability Company or one of these abbreviations as part of its name: LLC, L.L.C., LC, or L.C. In business transactions, correspondence, marketing, and so forth, it is important that the legal business entity name, including the chosen way to represent that it is a limited liability company, be used.
Owners of an LLC are called members. An LLC with just one owner is a single-member LLC. One with multiple owners is a multiple-member LLC. Members can have an active role in the management of an LLC or be passive investors in the company.
Articles of Organization give public notification of the formation of the business, ownership, location and the legal contact. They are registered with the Secretary of State for the State of Kansas here. The fee is $160 – $165. They need to be renewed annually and the registration needs to be renewed here. For for-profit businesses, the renewal cost is $50.
An Operating Agreement is a legal document that spells out important information for the ownership of the business. It is an internal document that does not get filed with the State of Kansas but should be retained by the business whether it is a single-member or multiple-member LLC. (See #4 below for more information below.)
More information about options for business legal structures can be found at the Kansas Secretary of State’s office.
6 Reasons to form an LLC
(1) To reduce personal liability on the part of a business’s owner or owners: By separating an owner’s personal assets from the business’ assets, a limited liability company limits an owner’s personal liability to the amount invested in the company should the business be sued. It does not completely eliminate the potential for personal liability in case of a law suit, it does not eliminate liability for debts for which any personal guarantees are given, and it does not protect the business from law suits. Another way to help protect assets is to carry adequate and appropriate insurances. (Read more about insurances here.)
So, questions to ask include: What personal assets do you have to protect? How much do you foresee your personal assets growing and, in turn, needing protection? What types of liability risks are associated with your business/industry? How severe are they? How likely are they to occur? How well are you personally covered by insurances for any liabilities potentially associated with your business? How comfortable are you with these risks?
(2) To establish some protection for the name of the business: By registering an LLC with the Secretary of State’s Office for the State of Kansas, no other business entity in the same industry has the right to use that name in Kansas. The restriction does not apply to businesses in an unrelated industries or to businesses outside of the State of Kansas. (You may also file a trademark with the State of Kansas. Read about state trademark registration here.)
So, a question to ask is: Would my business or brand be damaged if someone else were to open up another business with the same name, in the same industry, somewhere else in the state of Kansas?
(3) To validate the business as “a real business” in public perception: Some people think that a business is not reliable, serious, or legal, if it is not an LLC or a corporation. They think that it is just a hobby business, a fly-by-night business, not quite trustworthy or not quite legal. For some businesses, being able to put LLC at the end of the business name is an important part of branding.
So, questions to ask include: Are most other businesses in my industry structured as LLCs? Do my vendors, customers, or lenders expect businesses in my industry to be an LLC? Would being an LLC make my business look more professional ?- or is it acceptable to be a sole proprietor/partnership? – or is the expectation even higher, that businesses in my industry be corporations, e.g., for reasons specific insurances or bonding?
(4) To reduce some of the risks associated with having multiple owners of a business: In forming an LLC, it is important to have an operating agreement. An operating agreement is a legal document that spells out things such as how much each member has invested in the business in cash or other capital contributions, the purpose of the company, its management structure and the responsibilities of each member, how profits and losses are to be divided, how disputes will be resolved, what happens if someone wants to leave the company or if an owner passes away, the duration of the existence of the company and the terms and procedures for its dissolution. Having important information of these types written down and agreed upon literally helps multiple owners be on the same page.
So, questions to ask include: Do the owners of my business have a contract or other written documents that ensure that we are on the same page about important issues about which we, our spouses, or future owners of the business might need to agree? What is at stake if we do not have these things spelled out in writing?
(5) To avoid the double-taxation issues faced by shareholders of corporations: Typically, LLCs are structured so that the income tax liabilities of the business “flow through” onto the owners’ personal income taxes. Corporations, on the other hand, are taxed on profits and so are their owners – called “double taxation”. (Another option for avoiding double-taxation is to have the corporation set up as an S-Corp. Note, LLCs, can also be set up as S-Corps.)
So questions to ask include: On how much income in total do I need to pay income taxes? How much business income would I pay taxes on under the different structures? Do I, my spouse, other owners of the business have other sources of income on which we need to pay income tax? What are the tax rates for the different types of income?
(6) To enhance the value of the business in the context of succession planning: Related to the previous points, businesses that have operated as sole proprietorships or partnerships, sometimes elect to form LLC’s when they are in the process of getting ready to sell a business or transition it to new ownership as a way of enhancing the apparent and real value of the business.
So questions to ask include: Do I eventually plan to sell the business (or my portion of it)? Do I plan to transition it to employees or a family member? Given all of the various considerations, would having the business structured as an LLC make it more attractive to a future owner or owners?
If you are considering forming an LLC, evaluate what you want to accomplish and your options for achieving these goals. You may also need to discuss these things with your attorney and or accountant, as well as with other owners of the business, particularly when it comes to drafting your operating agreement or deciding on the best tax structure. Choosing the right legal structure can be to both the advantage of you, your family and your business.
Laurie Pieper, Ph.D.
Washburn University SBDC
America’s SBDC Kansas