When you're starting a business, there are several important decisions to make, including choosing a business entity. Many businesses have "LLC" in their name, but what does that mean and would it make sense for your business?
In this article, we'll cover seven signs that you should form a small business LLC. If you have any questions about whether or not it's the correct next step for your business, read on to learn the potential benefits of forming an LLC, signs it could be the right step for you, and how to keep your business protected.
Before making the decision to form a small business LLC, many business owners start out as sole proprietorships, which means that they are their business. All of their personal assets and business assets are tied into one; the same goes for liabilities.
By forming an LLC, you can separate your finances and the consequences that could impact them as a result of the risk you take in your business. If a sole proprietor is sued, for example, they could lose their home, car, or other valuable assets.
Let's say Susan, a hairdresser, starts her own business, which she registers as Susan's Scissors, LLC. Susan is able to keep her personal bank account and assets separate from the money that comes in and goes out of Susan's Scissors, LLC.
Without registering as an LLC, all of Susan's money would go to the same accounts, which could present a problem in certain situations, which we'll cover later on.
Do you work in a profession with a considerable amount of risk? In that case, forming a small business LLC may be best, specifically because of that separation between your business and personal assets we just discussed.
When you're registered as an LLC, most liabilities are assigned to the company and not the individual, so you can likely protect your personal assets..
Let's bring back Susan’s Scissors, LLC, to see how this would apply to a small business. If Susan accidentally cuts a customer while doing their hair, the customer could sue. Since she's registered as an LLC, the customer is suing Susan’s Scissors, LLC.
If Susan is found at fault and owes money, she won’t necessarily need to take it out of her personal accounts, because it may have to come from the business account.
Think you may not face many risks in your business? We'll discuss just how common risks really are for small business owners further on.
One of the main motivations for business owners registering their companies as an LLC is how they're taxed.
A single-member LLC can file the same as a sole proprietorship. If an LLC is registered as a C corporation, however, they'll have to pay double taxation, meaning that both the company and the owner have to pay taxes.
By forming an LLC, though, if you have one or more employees, you can be taxed as a partnership and typically avoid double taxation, meaning only the business will pay taxes.
For example, if Susan’s Scissors was registered as a C corporation, her business would have to pay taxes, and Susan would have to pay taxes based on her income as an owner as well.
However, if her business was registered as an LLC, only Susan’s Scissors, LLC, would owe federal income taxes, and Susan wouldn't have to pay a double tax on her income.
If you do hire an employee, you can register for an Employee Identification Number (EIN) with the IRS.
Each state has different laws and requirements around being taxed as an LLC. If you have questions, you can ask the IRS or consult a tax expert or accountant to understand your business’s specific requirements.
Running a business takes a lot of time and can also take a lot of money. Maybe you're applying for financial assistance to help get through an economic slump, or perhaps you need a loan to expand your business.
Regardless of your motivation, if you want financial assistance, choosing to form an LLC for your small business may be a good decision to consider. This, again, has to do with the separation of your personal and business assets.
When a financial institution is evaluating your loan application, it's likely they will check your personal finance history and credit. They check these things to make sure that if a liability were to occur, you're in good financial standing to handle the situation.
If you're a sole proprietor and have not-so-great personal credit, your personal assets and standing could reflect on your business, making your chances of getting a loan difficult.
If you register as an LLC, though, you're typically able to build credit for your business as well. When a financial institution is deciding whether or not to approve your loan request, you can rest easy, knowing your personal assets, like your house and car, may not be on the line.
While sole proprietorships are businesses owned by one person, forming an LLC gives you more flexibility if your business has more than one founder or if you decide to bring someone else onboard.
There are different ways to structure your LLC: either as a member-managed LLC or a manager-managed LLC. Managers of an LLC have the ability to make big decisions for the company that can include:
When forming an LLC, you will need to write an operating agreement that specifies who owns what percentage of the business and what their particular responsibilities are. This is where you typically would specify who is a manager and who is a member.
There can be more than one manager, but how their roles differ and how decisions will be made, including profit-sharing splits and other important factors, should be specified in the agreement.
For example: Susan wants Susan’s Scissors, LLC, to appeal to more customers. She decides to hire Ron, who is an experienced barber in town. Because Susan originally started the business, Susan and Ron decide that they will split the profits of their LLC 60/40, with Susan getting the larger piece of the business.
Susan and Ron decide that they will both be managers, but the weight of their decisions will be different, based on their ownership. They detail how future members (employees) at Susan’s Scissors, LLC, may be involved with decision-making at the company.
Typically, manager-managed LLCs do not allow for members to have the same power in decision-making as managers.
Since Susan and Ron are both managers of Susan’s Scissors, LLC, they can add as many employees as they'd like as their business grows over time. They can then consider making the employees members.
Speaking of employees and members, if you're ready to hire an employee, or already foresee yourself having them in the future, you may be ready to start an LLC.
When opening your LLC's doors to employees, it's important to do what you can to make working at your LLC most favorable. Especially if there's a chance that other businesses in your area and industry are hiring, it makes sense to ask, "How can I make my business competitive to new hires?"
Registering your business as an LLC and adding those three letters to your company name can give you authority that you may not have had previously. Becoming officially registered and adding LLC to your small business name helps potential employees know that you care enough to protect them and the business from potential liabilities.
You may think that you take every precaution possible to avoid liabilities, but we're all human, and more employees means more hands and a higher possibility of mistakes happening.
Keep in mind, that not every employee has to or needs to be a member of the LLC. If they're a member, they will not receive a share of profits via salary; if not a member and solely an employee, they will be compensated with a salary.
You can detail this fully within your operating agreement.
If you've been dreaming about your business and the ways you'll grow it, forming an LLC may be the logical step. The great thing about being an LLC is that it gives you flexibility to expand your business and update how it operates in the future.
An LLC has more flexibility when it comes to
, but they also typically have fewer requirements than other entities (such as corporations). If you're interested in a business entity that gives you the protection, authority, and flexibility that many entrepreneurs crave, then the LLC may be the right choice for you.
We mentioned that the separation of personal and business assets is one benefit of LLCs, which is because of how it impacts possible liabilities.
If you're a sole proprietor and an accident occurs, your personal assets could be on the line if you're sued by a customer. However, as an LLC, your business will be the entity sued, and your personal assets (like your car or home) are likely to be safeguarded.
But just because being an LLC provides a certain amount of security doesn't mean that mistakes won't happen. That's why it's important to get LLC insurance.
We mentioned earlier that human error can often lead to liability, and it's true — 43% of business owners surveyed reported being threatened with or involved in a lawsuit. So there's a good chance you may have to spend valuable time and money defending your business.
LLC insurance can help protect your small business from a variety of incidents. There are two types of coverage that an LLC business owner may want to get: general liability insurance and professional liability insurance.
General liability insurance, which is often referred to as commercial liability insurance, covers incidents such as:
Let's say that Susan’s Scissors, LLC, goes to a client's house to do their hair. Susan inadvertently spills hair dye on an expensive couch. The client sues Susan for the cost of a new couch.
Without LLC insurance, Susan may have to pay out-of-pocket for her client's new couch, taking money she'd planned to spend on improvements for her business.
With a general liability insurance policy, however, Susan could be covered to help replace the client's couch, as well as the legal fees she incurs, up to her policy limit.
Professional liability insurance is coverage that helps to protect against incidents such as:
Say Susan’s Scissors, LLC, is being sued because another hairstylist across town claims that she stole her idea for a back-to-school haircut special. The other stylist is suing Susan and is demanding a large sum of money.
With LLC insurance coverage, Susan can use her professional liability policy to help cover the requested fees and legal fees, up to her policy's limit.
Another type of LLC business insurance you may want to consider as a business owner is home-based business insurance. It's common, especially when starting out, for an LLC business owner to run their business out of their home.
While this is a great way to save money on overhead, it can be risky when it comes to liability protection. Many people may have homeowners insurance policies, but it's unlikely that they cover liabilities relating to your home-based business. This means that you may not have protection for your business if any of your property is damaged or stolen.
Now that you've seen how business insurance can benefit your small business, you may be wondering, "How do I get LLC insurance?" Like any business decision, we recommend doing your research. Reading this article is just one step!
Here are some other steps we recommend you take to find the best business insurance policy for you:
Before buying an LLC insurance policy, it's a good idea to understand the process of other business owners. Whether you talk to business owners in your industry or in your local community, it's worth asking how business owners compared coverage options and what impacted their decision.
They may even be willing to tell you about a time they had to file a claim and what their experience was like.
Every business is different, which means that every policy will be different too. After all, different businesses face different kinds of risks.
When shopping for an LLC insurance policy, take note of all the different types of risk you may face. Regardless of how big or small, we suggest noting these. That way when you are looking at coverage options, you can check to see which risks are and are not covered by the specific policies you're considering.
You most likely wouldn't buy the first car you look at, and we don't expect your shopping for insurance coverage to be any different. It's a smart business decision to know your options and shop around.
That's why at Simply Business, we make it easy for you to compare LLC insurance prices for free.
If you're a small business owner working to set yourself up for success, we hope this article gave you seven great reasons why you should consider starting an LLC.
You needed only one of those reasons to know it's smart to invest in LLC insurance, though. If you own a business, there’s a chance that something might happen and you'll need either financial or legal assistance to defend your business.
That's why it's important to invest in LLC insurance. After all, you should be focusing on doing your job well and not worrying about what mistakes could happen. With business insurance coverage, you can focus on your job, knowing that you're taken care of.
If you're considering forming an LLC, then you're most likely thinking of ways to grow your business. For more information on building your small business, head to Simply U, our blog for business owners.
I’ve told stories since I learned to talk and written since I could hold a pen. As a small business owner myself - I'm a freelance writer and yoga teacher - I love contributing to the entrepreneurship community in different ways (including writing for Simply Business!). When I’m not drafting articles for SB, I can be found on my yoga mat, perusing an indie bookstore, and writing (with my cat nearby of course).
Allison writes on a number of topics such as small business leadership, business structures, and employee training.
This content is for general, informational purposes only and is not intended to provide legal, tax, accounting, or financial advice. Please obtain expert advice from industry specific professionals who may better understand your business’s needs. Read our full disclaimer
*Harborway Insurance policies are underwritten by Spinnaker Insurance Company and reinsured by Munich Re, an A+ (Superior) rated insurance carrier by AM Best. Harborway Insurance is a brand name of Harborway Insurance Agency, LLC, a licensed insurance producer in all 50 states and the District of Columbia. California license #6004217.