One of the most critical steps in establishing your business is deciding on your business structure. Many small business owners choose to set themselves up as a limited liability company (LLC) because of the liability protection offered by this arrangement.
The requirements for LLC formation vary from state to state, but here, we'll provide a step-by-step guide of what you can expect from the process.
What is a limited liability company (LLC)?
A limited liability company is somewhat of a hybrid business structure, combining the features of a corporation and a partnership.
Like a corporation, an LLC provides the business owner with limited liability in the event that the company fails. But like a partnership, an LLC passes all profits to the LLC owners, where it is treated as the owners' personal income.
Benefits of an LLC
This "pass-through" taxation allows a limited liability company to receive its business profits as personal income, then pay federal taxes on this income. This avoids the possibility of "double taxation," where both owners and the company are taxed for annual earnings.
In addition, limited liability companies can be taxed in the same way as S corporations. This means that LLC members can be taxed as business employees, which can sometimes reduce your overall tax burden.
How much does it cost to start an LLC?
Here's where it gets tricky. When you create an LLC, you'll likely have to pay at least one of two costs. First, you'll have to pay the appropriate filing fee, ranging between $40 and $500 (depending on your state's rules).
Next, you may have to hire a professional LLC formation service. These professionals can help you with your formation documents and walk you through the process.
Of course, if you follow this LLC formation guide, you can save money and potentially get your business up and running faster.
How to start an LLC
Each state's rules will be slightly different, but you'll generally go through the following process to form an LLC.
You can also check the website of the Small Business Administration. The Small Business Administration can help you connect to the appropriate state-level organizations and forms you'll need to establish your limited liability company.
How to Start an LLC
- Give your company a business name
Your business name should reflect the identity of your business, and it should help you stand out from your competition. But depending on your state, you may need to avoid certain restricted words that imply that you're operating in a particular industry (such as "banking" or "insurance"). You can use these words only if you or an LLC member has a professional license in that field.
Some states also require that business names include an LLC designator at the end (i.e., "LLC," "Limited Liability Company," or simply "Limited Company").
State law often prohibits two businesses from having the same business name. You may need to search your state's records to confirm that your business name is unique.
We understand that this sounds a bit confusing. For further clarity on the exact specifications of your state, contact the state department associated with business filings (this is usually the Secretary of State).
- Register a DBA name
Some companies prefer to operate under a different name than their designated LLC name. This is known as a "doing business as" (DBA) name, though it can also be referred to as a trade name or an assumed name. If you choose to operate under an assumed name, you'll likely need to register this name with the state.
However, you can skip this step entirely if you prefer using your official LLC name.
- Identify a registered agent
You’ll want to designate a registered agent for your new business early in the process. What is a designated agent? A designated agent refers to someone who sends and receives legal papers and other documents on behalf of your company.
Usually, an LLC member can serve as a registered agent, though anyone 18 years or older can serve in this capacity.
- File your LLC articles of organization
Next, you'll need to file articles of organization to establish your LLC as a legal entity. Some states refer to this document as a "certificate of formation," but the form serves the same purpose.
You can find an organization form through the same state office you used to register your name or contact your Secretary of State. Most states provide this form online and allow businesses to file online.
The forms will ask for some basic information about your business, including:
- Your business name
- A description of your business purpose
- Contact information for you and your LLC members
- Contact information for your designated agent
- Your intended management structure
You'll then file your articles of organization with your Secretary of State, though some states may ask you to file with a different office.
This is also where the filing fee comes into play. If you're ever confused about the process of filing your articles of organization, check the website of the Small Business Administration for information, which can explain your state's process and the appropriate filing fee in greater detail.
- Publicize your LLC
Some states require limited liability companies to make a public announcement. If you're operating in Arizona, Nebraska, or New York, you'll need to publish the news about your LLC in at least one newspaper after getting initial approval.
For example, New York requires that limited liability companies be published in two newspapers as designated by the county clerk. The announcement must be made once a week for six consecutive weeks. After this time, you'll receive a Certificate of Publication from the newspaper, affidavits, and copies of the published notices.
These documents will then be submitted to the Secretary of State and retained as part of your business formation documents.
- Create an LLC operating agreement
In addition to your articles of incorporation, your state may also want you to create a written operating agreement for your business. But even if you're not required to draft an operating agreement, it's still a good idea to create one.
An operating agreement can be used as an internal document to ensure that all members are on the same page regarding managing the business.
Operating agreements are legal documents that define the structure and management rights of all of the members of your LLC. They consist of six principal parts:
- Management rights and voting procedure
- Financial contributions
- Distribution of assets
- Membership changes
- Dissolution of the LLC
You can draft your own operating agreement if you're operating a single-member LLC. On the other hand, if you have multiple business partners, you might want to seek legal advice on how to create your operating agreement equitably.
- Obtain your employer identification number (EIN)
Before you can conduct business, you'll need to obtain an employer identification number (EIN), which uniquely identifies your business entity. You need an EIN to hire any staff or open a business bank account.
You can apply for an EIN by visiting the IRS website, which has instructions on obtaining your EIN electronically or by mail.
Next steps: What to do after you form an LLC
You've filed your articles of organization and drafted your operating agreement. Now what? The following are some steps you can take to maintain your limited liability status and optimize how you do business.
Keep your LLC active
Perhaps most importantly, you'll need to know how to keep your LLC active to remain in good legal standing with your state. In some cases, this means filing an annual report or paying an annual filing fee to keep your information and account up-to-date.
Again, the website for your state's filing office or your Secretary of State can specify the exact requirements for remaining in good standing.
Register your LLC for state taxes
The type of taxes you pay will depend on the kind of business you operate. Retailers, for example, will have to submit sales taxes. Small businesses with employees will need to register for payroll taxes, including unemployment insurance tax and employee withholding tax.
Your annual report will also need to include updated information on your registered agent and any changes you may have made to your company in the past year.
Open a business bank account
Limited liability companies offer their owners protection from liability. But this protection demands that you keep your business and personal assets separate.
The best way to do this is by using a dedicated bank account for your business. In addition to keeping your finances separate, this will also help you to manage your business assets better. And if your LLC has more than one member, having a business account will make it possible for multiple people to share a bank account.
Obtain any additional licenses and permits
Some business activities may require additional licenses or permits. For example, if your restaurant serves alcohol, you'll need to obtain a liquor license before starting serving drinks. Your state may have additional licensing requirements for construction companies, public broadcasting, and agricultural activities.
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Frequently asked questions
Here are some of the most common questions we hear about running an LLC:
Unfortunately, the filing fee for your business is determined by state law, so there's not really any way to avoid it. Some states may even require you to submit an annual fee, which you'll have to factor into your business budget.
However, you can save money by using this guide to set up your own LLC rather than relying on third-party legal services. This can substantially reduce the cost of setup, and it may make the process faster since you'll have a better understanding of your business.
When it comes to business structure, "better" really depends on the nature of your business. Sole proprietorships are great for small businesses with only one owner. But an LLC is better for those who want to expand their business to include multiple owners or take advantage of the tax liabilities associated with this legal structure.
A limited liability company shields owners from personal liability if the business should go under, which provides better protection than you would find in a sole proprietorship.
Limited liability companies have some disadvantages you may want to consider. For example, an LLC isn't the best way to attract investors, so if you intend to offer public stock options in the future, you may need to structure your business as a corporation.
Additionally, many states dissolve the LLC if the owner dies or goes bankrupt. This can make it harder to form succession plans and pass the business along to family members in the future.