Are there any downsides to starting an LLC for my small business?
LLCs have their perks, but prepare for high costs, self-employment taxes and more.
LLCs are a popular choice for small businesses because it combines elements of a sole proprietorship with the limited liability protection of a corporation. That means you’ll get protection of your personal assets from being used to satisfy any business liabilities. You’ll also get pass-through taxation, which allows you to avoid the double taxation often associated with traditional corporations.
While a limited liability company (LLC) offers many advantages, it’s important to understand the potential disadvantages of an llc as well.
Disadvantages of starting an LLC
Let’s take a look at some difficulties you may face when choosing an LLC business structure.
1. High costs and ongoing fees
Costs to start an LLC typically include filing fees, attorney fees and ongoing fees for renewals and compliance. Filing fees can range anywhere from $40 to $500 depending on your state, and ongoing fees can range anywhere from around $300 to over $1,000 annually.
Other costs associated with starting your LLC might include business licenses and permits, publication fees and LLC name reservation fees. Plus, if you decide to get professional guidance for legal and tax matters, these services can add up for a small business or startup with limited resources.
However, costs vary depending on jurisdiction. Check with your official local government sites for more information.
2. You may be subject to self-employment taxes
LLCs are often treated as pass-through entities when it comes to taxes. This means that your business’s profits and losses flow through your personal tax returns. This setup can mean you’re responsible for self-employment taxes such as Social Security and Medicare contributions, which may be higher than a corporation’s tax structure.
3. Raising capital may be difficult
Having an LLC makes attracting investors much more difficult compared to a corporation. Investors tend to prefer corporations because they have a well-established framework for issuing shares and attracting equity investments. In contrast, LLCs pose a challenge because of a limited ownership structure, control concerns and regulatory limitations.
LLCs may need to rely on business loans, alternative financing and personal funds to fuel their growth.
4. Heavy reporting and record-keeping requirements
LLCs face a heavy administrative burden with requirements to maintain up-to-date and accurate records of all financial transactions, such as income, expenses, tax returns, contracts and assets. You’ll have to keep track of reporting and records yourself, which can be challenging for small businesses with limited resources. Or, you’ll have to hire accounting or bookkeeping professionals to help manage these tasks.
Along with keeping track of all financial transactions, LLCs are subject to compliance requirements set by your jurisdiction. In some cases, this means filing annual reports, updating public company information and paying required fees to do so. If you don’t meet these requirements, your business could face fines, penalties or even the loss of your LLC’s legal status.
5. Operating in multiple states is difficult
An LLCs requirements, regulations and protections are governed by state laws and vary from state to state. If you plan to operate in multiple states or move your business, this could mean additional legal and administrative costs and difficulties.
6. Transferring ownership can be complex
If you plan on bringing in new members, selling your business or passing it on, transferring ownership may be more difficult with an LLC compared to a corporation. An LLC typically has specific provisions outlined in its operating agreement for ownership transfers, which can limit the flexibility and ease of making a transfer. Plus, a change of ownership usually requires unanimous consent among members, so if even a single member disagrees, it can prevent any transaction from moving forward.
And, if you’re selling your business, you may encounter valuation challenges since LLCs often lack a readily available market for determining fair market value. This can make it challenging for buyers and sellers to agree on a fair price.
However, you can minimize future difficulties by including provisions in your operating agreement that outline a clear transfer of ownership process, valuation mechanisms and dispute resolution procedures.
7. LLCs may have a limited lifespan
In most cases, LLCs have a limited lifespan. Generally, an LLC may dissolve if a member dies, files bankruptcy or resigns. This can cause difficulties for long-term planning or transferring ownership.
However, if your state allows it, you can create a perpetual LLC. This allows your company to exist until all members dissolve it.
The downsides of choosing an LLC should be considered in the context of your jurisdiction, goals and business needs. Once you understand the pros and cons of an LLC, it may be helpful to consult with professionals, such as lawyers, accountants or business advisors, who can offer tailored advice for starting and operating an LLC.
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