Q.What are some the advantages and disadvantages to forming a L.L.C.?
A.The limited liability company (LLC) is a hybrid of the Partnership and Corporation. The LLC, if properly formed and maintained, offers limited liability protection (like a corporation) and pass-through tax treatment (like a partnership) to its members. In addition, it is probably the most flexible vehicle in terms of management and structuring economic sharing arrangements among the owners.
The LLC offers the following advantages:
- limited liability protection
- pass-through tax treatment
- less burdensome local and state reporting requirements than those required by corporations
- less upkeep and maintenance than a corporation
- greater flexibility than a corporation when it comes to management; the LLC can be structured to be managed by either its members (member-managed LLC) or an elected centralized management team (a manager-managed LLC) and the Operating Agreement can be drafted in such as manner that the members right to remove managers is limited.
- greater flexibility when it comes to income and loss distribution; for example, where one owner agrees to contribute all of the cash needed for the business, and another owner agrees to contribute by working full-time for the LLC, the parties might want to structure a preferred cash-on-cash return to the money partner. This can be easily done with an LLC, but would be very difficult to accomplish with an S corporation.
Despite the many advantages, the LLC does suffer from many drawbacks. First is the fact that the LLC is a relatively new entity and as such there is little legal precedent available to help owners predict how legal disputes may affect their businesses. In addition, in some states the LLC may have to pay higher income or franchise taxes and/or annual fees to operate. Moreover, the many advantages that stem from the flexibility offered by use of the LLC, in itself generally leads to higher formation costs since a detailed Operating Agreement (25 to 75 pages) should be prepared to meet the individual owners needs and expectations.
In sum: While the LLC may be more difficult and costly to properly form than a corporation because of the need for a detailed Operating Agreement, it is much more flexible in terms of structure and management, less burdensome in terms of local and state reporting requirements, and requires less upkeep and maintenance than a corporation. Thus while more difficult, and in turn more expensive to have properly formed, in the long run it is probably less costly to maintain.