How Do I start an LLC?February 27, 2021
So you want to start a business. Or you have a business and you want to protect yourself —and to build a solid foundation for growth — so you know you need some kind of limited liability company (LLC) or corporation. And you’ve decided that you want an LLC based on the differences between LLCs, C-corps, and S-corps.
Awesome! But now what?
Starting an LLC can seem either super easy or super difficult depending on how you view it. The truth is somewhere in between. It’s not rocket science — we’ll leave that to Tony Stark and/or Elon Musk — but it’s also not necessarily something you want to DIY.
We’re here to help. First, let’s see what kind of LLC you need, and the 6 top factors you need to consider before you start one.
What are the different types of LLCs?
Before we go any further, let’s talk about the different types of LLCs. (No, it’s not igneous, metamorphic, and sedimentary, but that’s a good guess.)
The first key question is: How many partners will there be in the business? We’re talking about folks who will actually be co-owners of the business — any co-owners of an LLC are called members. Just because someone is on your team does not mean they’re going to be a member (plus partnering up with anyone on a business is a decision in itself, and you and your colleagues may decide to operate via separate LLCs).
If it’s just you, and you don’t plan on adding any other members in the foreseeable future, then all you may need is a single-member LLC. This can be a positive, as they require less paperwork — both when you’re forming them and also when you’re doing your taxes each year. A single-member LLC is what the IRS considers a “pass-through entity” for tax purposes. And if it’s just you, then you can likely skip the operating agreement step we’re about to discuss.
If there are multiple members, then you need to figure out how decisions will be made and by whom, how the ownership percentages are divided up, etc. For any multi-member LLC, it is strongly recommended to have an operating agreement. This is like the constitution for your LLC, the foundational document upon which everything else is built; it’s akin to the bylaws for a corporation or a nonprofit.
If you don’t have an operating agreement, you’re inviting trouble. You and your partners may get along right now, but if anything goes wrong, you need to have an agreement that defines what happens. This is especially true if you have a handshake 50/50 split with a partner. What happens if you get deadlocked on an important decision? Many companies die when they reach this point, so make sure yours isn’t one of them.
Then, as you work on the operating agreement — hopefully with a small business lawyer — you’ll need to decide whether you want a manager. The question really boils down to whether you want to have a single executive who handles most of the decision-making, or whether the members will basically rule by committee. LLCs can designate a particular member as the manager who will have certain powers to act on behalf of the LLC, or you can decide that all members can act on behalf of the LLC, laying out how decisions will be made by the group. The right solution depends on your situation and the dynamics of the members — but the key is to get that operating agreement in writing as soon as possible.
The 6 top factors before forming any LLC
So now let’s take a look at the 6 top factors to consider before forming any LLC.
(1) How many partners or members are there?
Done! See above.
(2) If there a multiple members, do you want a manager?
Done! If you decide to have a manager, then some states will ask you to designate the LLC as a “manager-managed multi-member LLC” rather than a “member-managed multi-member LLC.” Wow, those government bureaucrats sure know how to party.
(3) What percentage should each member get?
If it’s just you, well, this one’s easy! But if you’re co-owning the LLC with other members, you need to decide who gets what percentage. Two key things to note here. First, in most states, the percentage interests do not have to align with how much capital members are contributing; members can “earn” their stake through work, customer contacts, etc. Second, the percentages usually need to add up to 100% rather than having a portion be unallocated for now (unlike with a corporation, where there can be unallocated stock).
(4)Are you prepared to keep a separate bank account, books, etc.?
This is critical. Once you create the LLC, the LLC (not you) should be the one to sign all of the LLC’s contracts, and the LLC needs to have separate finances, including a separate bank account. Otherwise you could lose the limited liability protections of the LLC and face personal liability for the company’s debts or actions. This is even true for everyday items like signing up for a web service like Gmail or Slack: it is a best practice to sign up as the LLC and pay from an LLC method of payment, like a debit card. The only personal payment an entrepreneur should make for a company is paying a lawyer to help start the company. As soon as the company is formed and it has a bank account, everything should be run from the company.
(5) How much capital are members contributing now, or later?
So if you think of the LLC as having a separate bank account and finances, and if it needs some seed capital to get started, who is going to contribute that?
(6) What state should I form the LLC in?
This is a whole topic on its own, and it depends on where you and any other members live, where the business is physically located (if anywhere), or whether you’d prefer to pick a gold-standard state like Delaware.
And we’re done! Now you’re ready to start your LLC — so your next step is to find an awesome small business lawyer who can discuss this with you and help you through the process. Hmm, if we only knew someone who could help?