- September 26, 2011
- Posted by: Orkun Ozkaymak, CPA, MBA
- Category: Business Formation
The limited liability company (LLC) is America’s newest form of business organization. There is little historical precedent for LLCs. They are essentially creations of the state legislatures, although some commentators trace the origin of the LLC to a 19th century form of business organization called the partnership association, or limited partnership association. The great bulk of laws authorizing LLCs in the United States were passed in the 1980s and 1990s. Wyoming passed the first law authorizing the LLC in 1977. Florida followed in 1982. The watershed event in the rise of the LLC was a 1988 Internal Revenue Service ruling that recognized partnership tax treatment for LLCs. Within six years, 46 states authorized LLCs as a business form. By 1996, Vermont, the last state to recognize LLCs, had an LLC statute in place.
The LLC is often described as a hybrid business form. It combines the liability protection of a corporation with the tax treatment and ease of administration of a partnership. As the name suggests, it offers liability protection to its owners for company debts and liabilities.
Simplicity and Flexibility
While LLCs are essentially new creations of state legislatures, corporations are truly ancient–and today’s corporate law still carries some unwanted baggage. The modern American corporation has antecedents that date to Roman times, inherited by us through English law. The basic principles of American corporate law have not changed significantly in centuries. Probably the single greatest disadvantage of the corporate form is the burdensome range of formalities that corporate managers must observe. A modern corporation’s heavy administrative burden is a remnant of the more traditional and formal legal system under which corporate law was cultivated.
The LLC changed all that. The LLC offers the liability protection benefits of the corporation without the corporation’s burdensome formalities. It is this simplicity that has made the LLC an instantly popular business form with businesspersons operating smaller companies.
Another attractive feature of LLCs that we will discuss throughout this book is their flexibility. LLC management can elect to be taxed either as partnerships or as corporations. An LLC can be managed like a partnership (a member-managed LLC) or like a corporation (manager-managed LLC). LLCs can create a board of directors, and can have a president and officers just like a corporation. LLCs can choose to have periodic meetings of their membership, or they can choose to ignore such formalities altogether.
Potential Disadvantages of the LLC
The LLC does carry some disadvantages that make it an undesirable business form for some purposes. The limited liability company is a new business form, and courts have not yet developed a body of legal precedent governing LLCs. Thus, LLC owners and professionals may face operating questions and issues for which they have little or no legal guidance. That said, this concern lessens as the states develop a reliable body of law concerning LLCs, and is no issue at all for very small companies. Furthermore, for companies that wish to pursue venture capital, accumulate a large number of shareholders, and/or eventually pursue an initial public offering, the LLC is not an appropriate alternative to a corporation. Venture capitalists and angel investors tend to shy away from investing in LLCs. That may change in the future, but today all large, publicly-held companies are corporations, not LLCs.
Advantages of the LLC
- LLCs do not require annual meetings and require few ongoing formalities.
- Owners are protected from personal liability for company debts and obligations.
- LLCs enjoy partnership-style, pass-through taxation, which is favorable to many small businesses.
Disadvantages of the LLC
- LLCs do not have a reliable body of legal precedent to guide owners and managers, although LLC law is becoming more reliable as time passes.
- An LLC is not an appropriate vehicle for businesses seeking to become public eventually, or to raise money in the capital markets.
- LLCs are more expensive to set up than partnerships.
- LLCs usually requires annual fees and periodic filings with the state.
- Some states do not allow the organization of LLCs for certain professional vocations.