Why do I need to create an LLC?

A recession might not seem like the best time to start a business, but as Paula recently wrote, a slowdown can provide you with the time and financial incentive to start that business you’ve been planning.

If you’re starting a new venture you should consider creating a limited liability company — an LLC.

Whether your new venture is selling wristbands announcing your new unemployment,  presenting makeup tips on YouTube, or tattooing pets, there is potential liability in your new venture.  While you should make every effort to deliver a quality service and satisfy your customers’ expectations, things can go wrong.

You might be daydreaming when tattooing Flufy’s name onto her, misspelling her name.  Your customer is heartbroken.  You offer to cross out the spelling error and try over.  Your customer doesn’t appreciate your grand gesture and decides, instead, to sue you. This is every entrepreneur’s worst nightmare.

Without the protection of an LLC, your personal assets are on the line — your checking account, savings account, house, boat… — everything.

The purpose of an LLC is to limit the liability of the company to the assets of the company.  Your personal assets are protected.  LLC’s were introduced across the US during the 1990′s, to encourage individuals to create businesses without the worry of risking their life’s savings.  Of course, if you commit an act of gross negligence or malice, you will be held personally liable, and you will not not have the benefit of limited liability.

It is important to identify which assets are associated with your new company.  It is your responsibility to define which assets belong to the business and which assets are your personal property.  Establish a separate business checking account, and use it for only business purposes.  Do not mix in your personal money (no commingling of funds).  Keep a record of what equipment was purchased with company funds and is used (preferably exclusively) for company business.  Should a judge need to settle a dispute, you want it to be clear which assets belong to you personally (and are therefore off-limits).

Establishing an LLC is relatively easy. Unless you have a special situation, you won’t need a lawyer.  Regulations vary by state, but the first stop is usually your state’s Secretary of State website.  Chances are you can file the forms online. You must choose a name for your new venture that identifies it uniquely within the state — that is, it must be reasonably distinguishable from similar sounding businesses.  The name must contain the phrase “Limited Liability Company”, or “LLC”, or similar.  You can search the state’s registry of existing businesses and a thorough Google should suffice.  You must choose a business structure — sole proprietorship or partnership (and that choice is a subject for another post).  Note that the “C” in LLC is for “company”, not “corporation”.  A corporation is, by definition, its own business entity, and cannot be an LLC.  A corporation pays taxes and can own property, and its liability is already limited to the corporate assets.  The fee for filing the LLC Certificate of Organization varies by state.  Massachusetts is relatively high at $500; Indiana charges only $90.  Once your LLC is created, there is usually an annual reporting requirement, and if you decide to close the business, you must file a notice of dissolution.

So good luck with your new venture, and think of the LLC as (relatively) cheap insurance.

Let me know if you’re thinking of creating an LLC and if you have any questions.

Image from tattoo-a-pet

This post was accepted into the Carnival of Personal Finance.

Tags: economic recovery, LLC, small business