Key Issues to Consider When Forming an LLC
Young entrepreneurs who are starting a business often elect the LLC structure. LLCs are beneficial because they provide pass-through taxation, which prevents income from being taxed twice. The LLC structure is also helpful in protecting owners from liabilities. However, owners must be sure that they are diligent when creating their company. The process of forming an LLC will impact a new business for years. Below are some of the key issues to consider when forming an LLC.
Where Should the LLC Be Organized
The process of forming an LLC can vary from state to state. New business owners often elect to register the company in the state where business operations will occur. This simplifies the process from an administrative perspective. It also could assist with aspects like the registered agent.
However, if you plan to run an online or eCommerce site, you may want to look into registering the company in a state other than the one in which you live. Attractive options to do so often include:
Additionally, owners will want to consider whether they will be conducting business in multiple states. If owners are prepared to do so, they’ll need to register their company in each one of the states in which they’ll transact business. Owners will select one state to file “domestically.” They will file as a “foreign entity” in all other states.
Choose a Name
Selecting a name for your new company is integral. Unfortunately, many new business owners don’t understand the nuances that go into choosing a name. For instance, practically every state requires an LLC to include an indicator in the name, such as “Limited Liability Company,” “LLC,” or an appropriate abbreviation.
Additionally, the new company is not allowed to have the same name as another LLC in the state. We recommend that entrepreneurs use a Name Availability Check to ensure that the name they’ve chosen for their company is unique.
Who Will Serve as the Registered Agent
The registered agent receives all legal correspondence on behalf of the company. As you could imagine, an agent is vital to a new company’s success. New business owners should take time to find a registered agent who they can trust, especially if they are opening a business in more than one state. The registered agent must either be an individual resident of the state or a third-party company authorized to conduct business in the state.
Obtaining an EIN and Setting Up a Bank Account
When forming an LLC, new owners will also want to look into acquiring an Employer Identification Number. The Internal Revenue Service provides one of these numbers to each company in the United States. Owners will need this number to pay federal taxes. Additionally, many banks require owners to present their EIN when opening a business bank account.
Opening a business banking account is critical for a new business. Too often, new business owners fail to draw a line in the sand between personal funds and company funds. Creating a separate account for the LLC will benefit with things such as taxes, expenses, and payroll.
Defining the Membership
Many states require entrepreneurs to establish the company’s membership upon formation. Additionally, when forming an LLC, owners will want to create a Membership Ledger. This is very similar to the stock ledger that a Corporation is required to maintain. The difference, of course, is that an LLC is not authorized to issue stock. However, members of an LLC can hold units of the company or own a portion of the entity.
The Membership Ledger helps promote transparency and contains essential information about who is a part of the company. The ledger should include the names and addresses of members in addition to the number of units they hold. Whenever there is a transfer of ownership or units, it should be recorded in the Membership Ledger.
Obtaining Business Licenses
Depending on the industry a new entrepreneur seeks to enter, he or she may need to get a license to conduct business. Licenses and permits exist at the local, state, and federal levels. Some cities, such as San Francisco, require companies to obtain a license for merely conducting business in that particular territory. Other common licenses are for industries and business activities such as restaurants, theaters, retail, manufacturing facilities, and auto repair shops.
Finding Investors
One of the downsides to forming an LLC is that the company may not be as attractive to investors. That’s because many investors prefer to put their money toward a Corporation, where they can receive stock in return. Because LLCs do not issue stock, entrepreneurs could find it a bit more challenging to attract investors. This tends to be the case with venture capital firms especially.
While entrepreneurs can issue ownership or units to investors, they may need to include such information on the paperwork they submit when registering the company. Some states don’t require information. But, if entrepreneurs register in a state that does, doing so could also trigger multiple securities laws, both at the state and federal levels. We advise young entrepreneurs to seek legal advice before doing this on a whim.
Furthermore, an experienced attorney can help entrepreneurs draft an Investor Rights Agreement. This will help define what rights, if any, the investors have to profits and distributions. It will also set the tax benefits that investors receive as well as their voting rights.
Articles of Organization
Once business owners have this information in place, they can move to file the Articles of Organization. In most states, the Secretary of State’s Office is in charge of accepting the Articles. Filing Articles of Incorporation is the official step needed to form the company. When completing these forms, owners will need to include vital information, such as the name and registered agent they’ve chosen.
Some states require owners to include information about the membership, as well as the purpose for the company’s formation. Lastly, states always require a fee with the Articles. Although this fee can vary drastically, it is usually about $100. Owners should be sure to check the individual requirements for each state before filing.