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Are LLC's always best for small businesses?
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Right now the popular business entity is a limited liability company or LLC. The initial benefits include liability protection, fewer reporting requirements than corporations, and avoiding double taxation. However, there are factors that many are missing that could lead them to choice a more appropriate business ownership entity.
Business owners should always place high on their priority list their options and ability to exit their investments. Yes it may seem counterproductive to be thinking exiting an investment before it even starts but in reality this is the best time. An LLC usually requires all remaining members to grant permission to a member to sell his membership to a third party. While this is a wise practice especially for a privately held company, it does provide a potential roadblock for a member to exit an investment in a timely and profitable manner if the relationship has soured since inception. Conversely, a corporation issues shares that can be sold without permission from other parties.
A common missed step in operating an LLC is lack of an executed operating agreement. An LLC does not by itself fully define ownership. The operating agreement defines the allocations of capital, profit & loss, and members duties. It is important that all members fully agree to the rules governing the LLC so future misunderstandings can be avoided. Thus, it is money well spent if you have an attorney prepare the operating agreement for membership signature even though the State of Florida does not require it. The shares of a corporation dictate that profits and loss be allocated in direct proportions with shares.
In the State of Florida, there are two longer term issues that may prove problematic. First, LLC’s are pass-through entities so all profits are passed onto the owners for taxation. Once the business becomes bigger, it will likely be advantageous that the owners separate themselves from the profitability of the company in order to reduce personal tax liability. Also, LLC’s will automatically terminate if 50% or more of the ownership is sold or exchanged in a 12 month period. Corporations do not have these issues.
For many small business owners, most of the benefits of LLC’s can also be found with a corporation that has received from IRS a small business corporation election commonly called S Corp. To become an S Corp is a two step process – 1) file articles of incorporation with your state and 2) file Form 2553 with the IRS within 75 days of filing articles. While S Corps are not best for all, it does address most of the issues discussed above. Therefore, business owners should discuss which is best for them both for the short and long term – LLC or S Corp.
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