Tom was beginning to think that his wife was right. It was time he opened a business checking account. Up until now, Tom had been running his paving business through the family’s checking account. Tom had a teaching job. His paving business was a summer sideline. But his business had grown from small jobs here and there to constant work all summer. So, down to the bank he went. And back home he quickly came. The bank wouldn’t open a business account unless Tom could show a legal document with the business name. The bank clerk had said something like an LLC.
Reasons
You may have several good reasons to form your own LLC. But why form your own LLC is a good question to ask. Know your reasons. Think of why you came to the question. Was it because you saw others whose success you admired operating their own LLCs? Was it because you went to the bank to open a business account, but the bank refused unless you showed them a business name on a legal document? If nothing in particular spurred your interest in an LLC, and you’re doing fine without one, then you may not need an LLC. The little time and trouble it takes to set one up, and the very little annual administration they require, won’t burden you enough to dissuade you. But don’t go to any trouble you would better avoid. That said, here are a few reasons for an LLC.
Banking
You may need an LLC for banking. Mixing your business deposits and payments into your personal account of deposits and payments can get messy. Having a separate bank account and statement for your business can simplify your business bookkeeping, so you can distinguish business income and expenses from personal income and expenses. But banks hesitate to open business accounts without a legal entity behind them. Banks have reporting requirements. IRS rules require banks to issue taxpayers a Form 1099 for interest income. Banks must also report cash transactions over $10,000 on Form 8300. Banks need legal names and numbers on their reporting documents. Banks generally won’t just open an account with a business name on it, without the business having a legal form and government-issued tracking number. An LLC is a solution. Show the bank your LLC articles of organization and EIN (see below), and you’ll be good to go.
Identity
You may also need an LLC for the business identity that it provides. Customers and clients like to do business with, well, a business. They may know that you are the business, but even so, they may want to see that you take your business seriously. You may be your own chief cook and bottle washer. But when you advertise, contract, and perform as Vintage Photography LLC or Market Consulting LLC rather than Joe Schmoe or Mary Contrary, customers and clients can at least see that you’ve got a thoughtful business name and legal business entity. Corporate customers or clients and suppliers may even refuse to do business with you if you have no business entity. You may find yourself unable to access goods, services, credit, or other business essentials without a business identity. An LLC addresses and solves those issues. The LLC is your business entity. You’re good to go.
Vision
You, too, may take your business more seriously once you establish an LLC. Working for yourself is an odd construct, almost like a split personality. Really, you’re just working when you’re working for yourself. You and your work have the same identity. When you form an LLC, though, you begin to distinguish yourself from the business entity you have formed. You begin to recognize the difference between your personal time and your work for the LLC. That distinction can be healthy. You may give greater effort to your work for the LLC, even while you step back and take appropriate time off for yourself. You can begin to have both a personal life and work life because you have a business entity apart from yourself. You can also fashion a clearer vision for your business entity, apart from but related to your own purpose and mission in life. And others can feed into your business vision through the LLC. Don’t underestimate the power of an LLC to lend order to your personal life while fueling your business vision.
Partnership
You may also want to work with others to pursue your business vision. You may have family members or friends you’d like to involve in your business or skilled acquaintances on whose talents you’d like to draw in partnership. You might be able to outright hire others or contract for their services. But hiring and contracting mean paying. You might not have the funds or want to risk the funds. Your interest may instead be to bring others into your business, sharing ownership, effort, risk, and profit together. You could form a partnership, but partnerships don’t limit liability to the entity. Indeed, as a partner, you’d be liable for obligations the other partners or the partnership incurs. An LLC enables you to share your business interest with other owners, while limiting business liability to the entity. Bringing others into the business is a good reason to form an LLC.
Investment
Attracting investors is another good reason to form an LLC. You may have family members, friends, or rich acquaintances with money to invest in your business. They may have money, or they may have a combination of money, time, insight, and skill. With an LLC, you can bring in other owners based on their contribution of money, labor, customers, supplier contacts, loans, intellectual property, equipment, premises, or anything else of value to your business. New businesses often succeed because they’ve found the right mix of owners with the right mix of resources, experience, time, and skills. When you form an LLC, you can assign membership interests among two or more owners based on their actual or anticipated, and promised, contributions. Once you form an LLC, you can also later grant new members percentage interests reflecting their new investments and contributions.
Value
Another good reason to form an LLC is that you may want to build value in your business entity. Earnings from a business are one thing, while building equity in the business is another. Why not do both? Building a valuable business can bring several advantages. You can borrow based on business earnings to further build the business. You can transfer the business to a family member through gift, sale, or inheritance. You can sell the business to invest the proceeds in another business or for retirement or other good purposes. Forming and operating an LLC enables you to build value in the LLC that you can later draw upon or transfer for your benefit. You can’t sell yourself, only your services. But you can sell an LLC after enjoying the income from its sold goods and services.
Building
You may have noticed that financially successful people aren’t necessarily earning lots of money. They may instead be building or acquiring appreciating assets. Indeed, lots of business owners withdraw little in earnings from their business, on which they would have to pay income taxes in any case. They instead leave the value in the business to grow untaxed. They’ve learned an important lesson. Some people work to earn while others work to own. Working to earn is fine. Indeed, it’s necessary, especially when starting out in life. Yet working to earn can take a long time to build savings and value. If you can work at the same time to own, you are increasing your net worth free of the burden of income taxes. Forming an LLC can help you build something to own at the same time that you work to earn. And working to own is a great way to build wealth, even generational wealth.
Succession
Another good reason to form an LLC is that it helps you plan for your business’s survival beyond your withdrawal, retirement, or death. Think of it. When it’s just you working, it’s hard to pass anything on whenever you stop. Oh, sure, you might have tools or equipment of value, maybe even secret recipes or patented designs. You could sell off these things or anything else remaining when you were all done. But the value of a business is seldom in its liquidated items. Businesses are generally valuable as going concerns. Their value lies in the business name, customer or client base, supplier relationships, systems, personnel, and processes, all things that need an organizing entity if their value is to survive. When you form and operate an LLC, you have a way of passing the LLC on to whomever you wish, as a going concern, with its full value.
Liability
Another good reason to form an LLC is for its limited liability. A later chapter addresses limited liability in detail, including how liability arises and how to use the LLC to limit it. Here, though, consider the advantage of limited liability itself, not how it works but what it does. Businesses are risky. That’s why we have the saying risky business. Nearly no matter what your business does, it carries some risk. The risk may be of nonperformance, that your business doesn’t do what it promised to some customer or client. The risk may be owing an office lease or vehicle finance that the business can no longer pay. The risk may be that someone gets seriously injured from the business’s negligence. Your business should insure against risks. But sometimes, the insurance isn’t enough or doesn’t cover the risk. Do you want to pay? Do you want to lose your home, car, or savings, or owe a judgment that it takes years of work to pay? An LLC keeps business risks with the business. If the LLC fails in some respect, you don’t.
Alternatives
So, you can see several good reasons to form an LLC through which to conduct your business. You do have alternatives to an LLC that may satisfy some or all the above reasons. You could, for instance, simply adopt an assumed name, otherwise known as doing business as or a d/b/a. Adopting an assumed name is generally as easy as filing a certificate of assumed name with the county or state. But a d/b/a doesn’t give you a separate entity and doesn’t limit your liability. You could alternatively go to work in someone else’s business. But that doesn’t give you any ownership interest of value. You could form a partnership, but a partnership doesn’t limit liability. You could form a corporation, but a corporation might get doubled taxed and is generally harder, more complex, and more expensive to administer. The alternatives aren’t great. Give it some thought. It might be time for an LLC.
Key Points
An LLC can help you keep your business accounts and books straight.
An LLC helps you build something of value beyond your earnings.
You can sell, gift, or otherwise transfer an LLC as a going concern.
An LLC survives your withdrawal, retirement, or death.
An LLC helps you arrange for succession to keep the business going.
An LLC enables you to limit business liabilities to the entity.
Consider partnership, corporation, or assumed name alternatives.