If you have decided to start a business, there are a number of crucial decisions you’ll have to make about your company’s legal structures.
The first question you’ll likely find yourself asking is, “What type of business is this going to be?”
While the partnership or corporation structure is better suited to some businesses, the limited liability company (LLC) has become one of the most popular business structures over the past few decades.
An LLC is a business entity that protects its owners, referred to as members, from being personally liable for the debts of the company.
But how exactly do LLCs work?
At Generations Law Group, we’ve been helping clients minimize taxes, prevent claims from creditors, and ensure their legacies for decades. In this blog, we’ll discuss the pros and cons of choosing an LLC framework to legally structure your business.
Types of LLCs
The LLC structure provides its members with legal protection against lawsuits and requires less paperwork and formality than a corporation. Also, unlike a corporation in which the directors are tasked with making the decisions, in an LLC, the members are the default decision-makers.
There are two common management structures for LLCs: manager-managed and member-managed.
1. Manager-managed LLCs
Creating a manager-managed LLC is similar to creating a corporation: the managers—who may or may not be members—act like a board of directors in a corporation (and the owners or managers are like the shareholders of a corporation).
In a manager-managed LLC, the managers make the day-to-day decisions for the business and only involve the members in big decisions.
Members might be consulted on the addition or removal of a member, a change in the nature of the business, or amendments to the LLC’s charter.
In Idaho, if members disagree with a decision of the manager in a manager-managed LLC, the members may remove the manager by majority vote, unless another procedure is set forth in the operating agreement.
2. Member-managed LLCs
By contrast, in a member-managed LLC, the members have the power and ability to make all of the decisions for the company. These decision-making responsibilities can range from mundane daily operations to major decisions such as adding or removing a member or dissolving the business.
Without an operating agreement specifying otherwise, the assumption is that each member has equal shares and voting rights. An even number of owners can lead to an impasse in making decisions, which could delay business operations or even harm the business.
Pros of choosing an LLC in Idaho
Under Idaho state law, unless the operating agreement states otherwise, LLCs are assumed to be member-managed by default. As a result, this is the most common type of LLC management structure.
But however the company’s operating agreement organizes its management structure, all LLCs share some common legal benefits that other company types, like corporations, lack:
- Limited Liability: The defining characteristic of an LLC is its limited liability protection. This benefit allows LLC members to legally separate their personal assets from the company’s assets, which allows members to conduct business with less risk to their personal property.
- Pass-Through Taxation: Another benefit of forming an LLC is the opportunity to avoid double taxation. LLCs are not taxed at both the entity and ownership levels; they are taxed only at the ownership level. In other words, the business’s taxes pass through to its owners. While LLCs receive pass-through taxation by default, they can also elect to be recognized as a regular corporation for tax purposes (which would make them subject to double taxation), or as an S-corporation, which avoids double taxation like an LLC. This ability to decide how to be taxed by the IRS is a desirable feature of the LLC.
- Customizable Management Structure: As we discussed above, the LLC does not mandate any particular management structure. Members can decide whether to pursue a member-managed or manager-managed company structure. There is also no mandate regarding the number of people who can own or manage the LLC. This allows LLC members to choose the management structure that works best for their LLC.
- Relaxed Compliance Requirements: Finally, LLCs are governed by less stringent compliance requirements. Unlike corporations, LLCs do not have required annual meetings and boards of directors. The documentation and reporting requirements are also more lenient. As a result, smaller businesses that do not run complex operations can enjoy a legal structure that meets their unique needs. If LLC members want to add mandates to their company, they can do so in the operating agreement.
Cons of choosing an LLC in Idaho
While there are many benefits to structuring your business as an LLC, there is a cost for flexibility.
The following are some of the key drawbacks to consider:
- Loss of Limited Liability: Although an LLC enjoys limited liability, poor practices could result in an LLC losing its liability shield. Companies can sometimes fail to properly maintain a separation between the company’s business assets and the members’ assets by keeping separate bank accounts, complying with state regulations, and maintaining proper records. As a result, a court may find grounds to pierce the veil and attack personal assets during litigation.
- Pass-Through Taxation: Pass-through taxation can have drawbacks for LLC members because they will be taxed whether dividends are paid out or not. This means that LLC owners must report the LLC’s profits and losses on their individual tax returns and must pay in proportion to the profits the company makes, even if those profits are not distributed to the members. As a result, members may elect to classify the LLC as a corporation for tax purposes.
- Management Disputes: Because LLCs are often managed by multiple managers, it is common for LLC members to come into conflict. While these disputes can be healthy for the business and help the business grow, some disputes might be more serious and irreconcilable. The most common disputes between members involve compensation, responsibilities, and unethical conduct. If these disputes cannot be resolved internally, members may have to hire a neutral third party to facilitate mediation, or even take the dispute to court.
- Difficulty Obtaining Investors: The looser structure of an LLC can make it less appealing for investors, for a number of reasons. For one, it can be more challenging to ensure returns on investments absent structural elements like mandatory meetings and reports, which provide accountability. In addition, investors’ interests are less liquid because there are often limits on transferring LLC membership interests and an absence of interested buyers. If an LLC’s members eventually decide that a new entity type better suits their investors’ needs, they may find the process of converting the entity to be expensive and challenging.
The best way for Idaho business owners to assess their circumstances and determine whether the pros outweigh the cons is to consult an attorney with experience in business formation.
Hire a business formation attorney in Idaho today
Starting a business is an exciting adventure– but it can also be stressful and full of hard decisions. If you need help deciding whether an LLC is the right legal structure for your business, Generations Law Group can help.