Disadvantages of an LLC. Are There Any?

You have probably heard the term “LLC” thrown around, often associated with good things.  But the truth is, most aren’t aware of what an LLC is or does for a business owner.  I know this because the top Google search terms of an LLC include “what does an llc do?”  Or even the basics like “llc meaning?” (I mean, who really uses capital letters in google searches anyway?)

This blog will explain the basics of an LLC and hopefully flesh out some of the advantages, disadvantages and whether it is a good choice for your new business.

First, the meaning of LLC is Limited Liability Company.  As the name suggests, it limits a business owner’s obligation to creditors so that the owner is personally protected from the actions or debts of the LLC. In other words, it puts a wall between the owner’s personal assets and the company’s liabilities, or as we in the biz like to say, it puts up a “corporate veil.”  That means if the LLC is sued, the business owner’s things, like home, bank accounts, etc., cannot be used to pay the creditor because the veil is protecting it. 

Compare this with a sole proprietor example.  A sole proprietorship is the owner who starts his or her own business without filing any paperwork or registering with the state. Simple to start and easy to maintain, but the liability exposure to the owner’s personal assets is through the roof! 

So all good with the LLC right?  Well, in some instances, it may not be. 

First, when you create an LLC, whether a “single member,” that’s you individually, or a “multi member,” that’s you with one or more folks, it does require filing

Articles of Organization with the Secretary of State, creating an Operating Agreement (your recipe book), and here’s the kicker – following the operating agreement.

If you only file your Articles of Organization and do not create and follow your operating agreement, you risk piercing the corporate veil.  Another fancy legal term for: business creditor can get at your personal sh*t. This is especially risky with single member LLCs. So you must not only create the document, but maintain the continued obligations of the LLC per your operating agreement.  (Hot tip: Do not google the popular search term “Legalzoom LLC” to get an operating agreement together.  It may not be compliant in the state in which you are doing business or leave out some significant provisions.)  These obligations could relate to management format, annual meetings, liability of members, and so on.  If a court finds that you completely disregarded the provisions of the agreement, you could be SOL.

Next, you can’t drain all of the assets of the LLC

so that if the business is sued, there is no money to satisfy the judgment.  Courts (and the IRS) can see through this. 

On the same token, you cannot commingle funds,

or mix your business money with your personal money.  Don’t pay your personal debts out of your business account, don’t deposit your business income into your personal account.  This is sure way to not only pierce the veil, but also piss off the IRS and get yourself audited.

Lastly, if you are going to enter into a contract with another business or person, make sure that you do it as a manager or member of the LLC. 

If you sign it personally, you are personally responsible for the obligations in the contract. Don’t do that to yourself.

Summing it all up, an LLC has amazing liability protecting (and tax – see S Corp blog) advantages.  It can be an asset to almost any entrepreneur, from medical practitioner to Etsy seller. 

However, if you are just starting out in a very low risk business and don’t have the help or wherewithal to sustain the ongoing requirements of an LLC, you may decide to save yourself the cost and time of forming an LLC.

 Either way, it is advisable that you consult with your attorney (and accountant) on these issues.