What are the Advantages and Disadvantages of Having a Limited Liability Company?

Excerpted from Complete Limited Liability Company Kit by Mark Warda ©2005

Before forming a limited liability company, the business owner or prospective business owner should become familiar with the advantages and disadvantages of the LLC and how they compare to those of other business entities.

Compared to Proprietorships and Partnerships
The limited liability company offers the greatest benefits when compared to partnerships and sole proprietorships. Now that the LLC structure is available, it is advisable for most partnerships and sole proprietorships to switch.

Advantages
There are several advantages to having your business be an LLC. This section describes some of those advantages and how to apply them to certain situations.

Limited Liability
The main reason for forming a limited liability company or corporation is to limit the liability of the owners. In a sole proprietorship or partnership, the owners are personally liable for the debts and liabilities of the business, and creditors can go after nearly all of their assets to collect. If an LLC is formed and operated properly, the owners can be protected from all such liability.

Example 1: If several people are in a partnership and one of them makes many large, extravagant purchases in the name of the partnership, the other partners can be liable for the full amount of all such purchases. The creditors can take the bank accounts, cars, real estate, and other property of any partner to pay the debts of the partnership. If only one partner has money, he or she may have to pay all of the debts accumulated by the other partners. When doing business in the LLC or corporate form, the business may go bankrupt and the shareholders may lose their initial investment, but the creditors cannot touch the personal assets of the owners.

Example 2: If an employee of a partnership causes a terrible accident, the partnership and all the partners can be held personally liable for millions of dollars in damages. With a corporation or LLC, only the business would be liable whether or not there was enough money to cover the damages. One true story involves a business owner who owned hundreds of taxis. He put one or two in each of hundreds of different corporations that he owned. Each corporation only had minimum insurance and when one taxi was involved in an accident, the owner only lost the assets of that corporation. The injured party tried to reach the owner’s other assets, but the court ruled that this was a valid use of the corporate structure.

Note: If a member of a limited liability company does something negligent, signs a debt personally,or guarantees a company debt, the limited liability company will not protect him or her from the consequences of his or her own act or from the debt. Also, if a limited liability company fails to follow proper formalities, a court may use that as an excuse to hold the members liable. The formalities include having separate bank accounts, filing annual reports, and following other requirements of state law.

Since the limited liability company is relatively new, there have been few cases interpreting the law. Courts will most likely look to both corporation and partnership law when ruling in a limited liability company case. When a court ignores a corporate structure and holds the owners or officers liable, it is called piercing the corporate veil. (It is not yet clear how or when the courts would allow a party to pierce the LLC structure.)

Continuous Existence
A limited liability company may have a perpetual existence. When a sole proprietor dies, the assets of his or her business may pass to the heirs but the business no longer exists. (This may also happen with a partnership if it is not set up right.) If the surviving spouse or other heirs of a business owner want to continue the business in their own names, they will be considered a new business—even if they are using the assets of the old business. With a partnership, the death of one partner can cause a dissolution of the business if there is no provision in the partnership agreement for it to continue.

Example: If the owner of a sole proprietorship dies, his or her spouse may want to continue the business. That person may inherit all of the assets, but would have to start a new business. This means getting new licenses and tax numbers, registering the name, and establishing credit from scratch. With an LLC, the business continues with all of the same licenses, bank accounts, and so on.

Ease of Transferability
A limited liability company and all of its assets and accounts may be transferred by the simple transfer of interest in the company. With a sole proprietorship, each of the individual assets must be transferred and the accounts, licenses, and permits must be individually transferred.

Example: If a sole proprietorship is sold, the new owner will have to get a new occupational license, set up his or her own bank account, and apply for a new taxpayer identification number. The title to any vehicles or real estate will have to be put in his or her name, and all open accounts will have to be changed to his or her name. He or she will probably have to submit new credit applications. With an LLC or corporation, all of these items remain in the same business name and are under control of the new manager or officer.

Note: In some cases, the new owners will have to submit personal applications for such things as credit lines or liquor licenses.

Sharing Ownership
With a limited liability company, the owner of a business can share the profits of a business without giving up control. This is done by setting up the share of profits separate from the share of ownership.

Example: John wants to give his children some of the profits of his business. He can make them members of the company entitled to a share of the profits without giving them any control over the management. This would not be practical with a partnership or sole proprietorship.

Ease of Raising Capital
A limited liability company may raise capital by admitting new members or borrowing money. In most cases, a business does not pay taxes on money it raises through the sale of its shares.

Example: If an LLC or corporation wants to expand, the owners can sell ten percent, fifty percent, or ninety percent of the ownership and still remain in control of the business. The people putting up the money may be more willing to invest if they know they will have a piece of the action than if they were making a loan with a limited return. They may not want to become partners in a partnership.

Note: There are strict rules about selling interests in businesses with criminal penalties and triple damages for violators.

Separate Record Keeping
An LLC has all its own bank accounts and records. A sole proprietor may have trouble differentiating which expenses were for business and which were for personal items.

Ease of Estate Planning
With an LLC or corporation, shares of a company can be distributed more easily than with a partnership or sole proprietorship. Different heirs can be given different percentages, and control can be limited to those who are most capable.

Prestige
The name of an LLC or corporation sounds more

As Featured in the Book

Complete Limited Liability Company Kit (+ CD-ROM)

Mark Warda, Attorney at Law

The Complete Limited Liability Company Kit explains why the limited liability company is the best choice for many new small businesses, and how you can take advantage of this type of business.

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