What is an LLC? Definition and how to form one

As a solopreneur, you may find yourself becoming the face of your business. If you’re front and center for your personal brand, it’s important to legally distinguish between you and your company from the beginning. You can accomplish this by setting up an LLC.

An LLC is a legal entity designed to protect business owners from any liabilities the company may accumulate. Not only does forming an LLC help separate personal assets from business liabilities, it can also signal to potential customers and stakeholders that you are serious about your venture.

Read our guide to learn how to start an LLC, the different types of LLCs available for you to choose from, and the pros and cons of this business structure.

How does an LLC work?

An LLC works by creating an operating agreement that outlines ownership and operational protocols for every member. The LLC must file this agreement with the state it operates in and comply with state requirements, such as filing annual reports and paying relevant fees.

According to the IRS, the following entities can be LLC members in most states:

• Individuals
• Corporations
• Other LLCs
• Foreign entities

This business structure accommodates one or multiple members, who manage the LLC themselves or appoint managers to oversee daily operations—allowing for adaptable ownership and management arrangements for solopreneurs who prioritize flexibility.

An LLC also provides tax benefits to its owners. LLC members can elect to enroll in pass-through taxation, meaning profits and losses flow through to individual members who report them on personal tax returns.

Types of LLCs 

The LLC definition includes multiple management structures so members can easily adapt to the needs of their business and operate in a model that works most effectively. Let’s take a look at the four main types of LLCs.

Single-member LLCs  

Best for an entrepreneur who operates their business alone

Example: A freelance book illustrator

A single-member LLC exists when there is only one person associated with the company. Filing as a single-member LLC is advantageous because of the liability protection the owner receives. If an individual were to form a sole proprietorship instead of a single-member LLC, they would be responsible for the business’s debts and liabilities.

Multimember LLCs

Best for small businesses with multiple stakeholders

Example: A restaurant owned by two chefs

A multimember LLC is an LLC consisting of more than one member. For this business structure to operate within legal bounds, all members must sign the company's operating agreement. Apart from this requirement, the process of establishing a multiple-member LLC closely resembles its single-member counterpart.

Member-managed LLCs 

Best for business owners who want a hands-on approach

Example: An e-commerce startup founded by tech professionals

In a member-managed LLC, the owner– or owners – make up the membership of the company. Each member has a vote when it comes to making business decisions. Everyone’s vote counts equally and must be considered when changing company management or operations. This type of LLC is great for entities with one or multiple members who all want to have a say in the day-to-day operations of their business.

Manager-managed LLCs

Best for LLCs with owners who don’t want to play an active role

Example: A real estate investing LLC for potentially passive income

In a manager-managed LLC, the members are not in control of the day-to-day business operations. Instead, LLC owners elect managers to run the company. The owners are in charge of filling management positions. Those in management positions are then responsible for handling business activities. LLC owners take a much more hands-off role.

What are the pros and cons of an LLC?

Now that you have a better idea of what an LLC is, let’s take a more in-depth look at some of the pros and cons of this business structure. 

Some of the benefits of an LLC include:

• LLC taxation: Members won’t have to worry about having their earnings and losses taxed at the corporate tax rate. Instead, LLC owners merely “pass the income through” to their personal tax returns, and then pay one tax at the individual level.
• Low restrictions on memberships: There are no restrictions on the number of members or owners that can exist in an LLC. There are also no restrictions on the types of members that can exist. In most states, almost anybody can join to form an LLC.

• Limited liability protection: Upon registering as an LLC, owners immediately provide themselves with a “corporate veil” of protection that is hard to pierce. This directly protects owners against the debts and liabilities the business accrues.

• Flexible management structure: There are no structure requirements that LLCs must meet. LLC owners can organize the business any way they see fit.

• Minimal maintenance: LLC members do not have to meet regularly, or eve ever, if they so choose. Therefore, it’s easier to run an LLC than it is to run a corporation.

Although the pass-through tax benefits and low maintenance management options are appealing for solopreneurs seeking a simple business solution, becoming a member of an LLC also has potential drawbacks.

Here are some LLC disadvantages to carefully consider:

• Minimal legal precedent: Since corporations have existed for hundreds of years and the first LLC was formed in 1977, there is a lack of past legal disputes to help guide present-day issues for LLCs — especially when compared to other business types.

• Transferring ownership is difficult: Not only must all other owners consent to the ownership transfer, but state law must permit it as well. Owners will need to complete dozens of legal documents indicating the transfer of ownership for it to be successful.

• High costs of formation: Prospective LLC members should know that the cost of creation can be quite expensive. The cost of filing varies from state to state, so check your Secretary of State’s website for accurate filing cost information.

• May not attract investors: Some investors may prefer to work with corporations where a board of directors is in place. Investors also tend to like that they can buy and sell shares of a corporation whenever they’d like. If investors were to buy into an LLC, it would then be challenging for them to sell their ownership stake and exit the company.

Now that you’re familiar with the pros and cons of becoming a member of an LLC, let’s take a deep dive into how LLCs compare with other business entity structures.

LLC vs. Other business entities 

An LLC isn’t like other legal entity options. It’s a business structure that prioritizes flexibility and simplicity at its core. Each member receives limited liability protection and has few restrictions on how they must manage their business.

Unlike an LLC, there are membership restrictions that come with other types of business entities. For instance, if your business registers as a sole proprietorship, you can exist only as yourself. If you register as a partnership, you can exist only with one other person. Let’s take a look at how an LLC compares to other business entities:

• LLC vs. sole proprietorships: A sole proprietorship is an unincorporated business owned by one individual, with no legal distinction between the business and the owner. In contrast, an LLC provides limited liability protection to its owners.
• LLC vs. partnerships: Partnerships involve two or more individuals sharing the profits and liabilities of a business. Similar to sole proprietorships, partnerships do not provide limited liability protection.  In contrast, an LLC offers limited liability to its members and allows for a more flexible management structure compared to traditional partnerships.
• LLC vs. corporations: Corporations are legal entities separate from their owners, providing limited liability protection and the ability to raise capital through the issuance of stocks. In comparison, an LLC also offers limited liability protection but with more operational flexibility and simplified maintenance requirements than corporations.
• LLC vs. S corps: Both LLCs and S corps offer limited liability protection to their owners and have the option for pass-through taxation. However, S corporations are subject to restrictions on ownership and the types of shareholders they can have, while LLCs have more flexibility in these areas and generally simpler operational requirements.

Now that you know how an LLC works, its pros and cons, and how an LLC stacks up against other business structures, let’s learn how to form one.

Forming an LLC 

Once you decide that this is the right business structure for your goals, you can form an LLC in seven simple steps. Here’s how:

1. Register an LLC name: Choose an available business name, or “doing business as” (DBA) name, to register with your secretary of state office. It must be unique and identify that your entity is an LLC.
2. Choose a registered agent: Your state may require that your LLC has a registered agent, someone who can facilitate communication between members and the government on behalf of your business.
3. Outline an operating agreement: This internal document will serve as the guide to how the LLC functions and the roles each member will play within the organization. It should include everything from growth goals to potential conflict resolution options.
4. File your documents with the state: Although you won’t need to file your operating agreement, you will need to file articles of organization with your state. These articles will include items like your business name and management style.
5. Obtain an EIN and business bank account: To be a legal entity capable of receiving and paying taxes, you’ll need to obtain an employer identification number (EIN) and a business bank account–ensuring your personal and professional finances differ.
6. Get any relevant permits and licenses: Depending on the kind of business your LLC will operate, you may need to obtain industry-specific permits or a sales tax license to be able to sell goods or services.
7. Adhere to LLC requirements: Although an LLC is notoriously simple to maintain, you’ll want to remain cognizant of any local requirements or changes to policies that your state may have. 

If you’re able to complete these steps and adhere to the latest policies from your state, you’ll be able to maintain an LLC on your own– or with fellow members of the entity.

Start your business with confidence 

Starting an LLC means engaging in a simple business structure that allows members to adapt their management style to the needs of their business. Given that tax benefits are one of the major advantages of starting a business under an LLC, it’s essential that members use effective accounting software to ensure smooth operation and accurate financial documentation.