Six Questions to Ask Before Forming an LLC

So you're looking to start a business and you've decided that forming a limited liability company (LLC) is the best fit for your company. The decisions you make when starting your business can have long-term consequences. When creating your LLC, there are six questions you should consider before you file any official documents.

This article assumes that you've already chosen an LLC as your preferred entity type (instead of a corporation, partnership, sole proprietorship, or other business structure), based on factors that are relevant to your particular situation. For further information, read how to choose the best ownership structure for your business.

Which State Is Best to Form an LLC?

A variety of factors can determine which state you decide to form your LLC in. The most obvious choice is usually the state where you're physically located and you expect to conduct your business. But you usually don't have to form your LLC in the same state where it'll operate.

You might choose to form an LLC in a state because of its:

• user-friendly online business services
• limited public access to confidential company information
• favorable tax treatment
• fine-tuned corporate legal system, and
• well-developed corporate case law.

For example, Florida allows you to easily file and access your LLC documents online through its corporations division website.

Delaware is generally favored by those looking to form LLCs (or corporations). While it doesn't have online filing services, Delaware does offer privacy, favorable tax treatment, a structured corporate system, and detailed laws. So, business owners who decide to form their LLC in Delaware can be more certain about how corporate laws apply to them and readily take advantage of the tax benefits.

For additional information, read our article on where to form your LLC.

How Should I Choose a Name for My LLC?

Before you choose a name for your LLC, it's important to do your research to make sure your proposed business name is available to use. Checking whether you can use your desired name at the beginning can potentially save you future aggravation. For instance, if you choose a name that's already been claimed, you might have to later abandon your name and pay money damages to the rightful owner of the name.

Following state legal requirements. You should also look at the LLC laws in your state of formation to make sure your preferred LLC name satisfies all legal requirements. For example, many states require your business name to include "limited liability company" or "LLC." (For specific state requirements, check out our state guide to forming an LLC.).

Changing your company's name. The good news is that you can always change the legal name of your LLC if you need to. Every state has a different process for changing the name of a company—some more complicated than others.

Furthermore, if you want to do business under another name, you can avoid changing the legal name of your company by filing a fictitious business name (FBN)—also known as a "doing-business-as" (DBA) or "assumed name". You'll need to file your FBN at the state, county, or city level. You should check local requirements to find out what form and fee to file. (For more information, see how to register your business name.)

Fictitious names can also be very useful if you want to vary your business's name by geographic location or assign different names to separate divisions within the company. By using these names, you can avoid formally creating new subsidiaries.

Should My LLC Have Investors?

Starting a business with your own money typically makes things a lot less complicated. Having investors who expect to make returns on their investments can add complexity to your LLC in many ways.

The demands of the investors might depend on how many investors you have:

• When there's one investor. If there's only one investor, then that person might want to be fully repaid before any other owners (called "members") receive distributions on their ownership interests (called "membership interests").
• When there's more than one investor. Multiple investors will likely want to have the LLC repay them on identical timelines, with repayments made proportionally based on their respective membership interests. For instance, if Investor A has a 20% interest and Investor B has a 25% interest, then Investor A will be paid 20% of the profits and Investor B 25% of the profits until they're paid back.

Sometimes the investors will agree that they don't need their money returned until the LLC is sold or liquidated. In that case, the other members might not get a penny until the investors have been repaid in full.

The negotiation of these terms will depend on the relationships and relative bargaining power among the parties. In any case, the financial understanding between you and any investors should be fully laid out in a written operating agreement. The operating agreement should be signed by you, the investors, and the other members at the time you form the LLC.

The operating agreement could also include any other rights demanded by the investors in:

• controlling the company's management
• selling the business, and
• preventing other members from transferring their membership interests.

Who Owns My LLC?

If you'll be the sole owner of your LLC, you'll create a single-member LLC. In a single-member LLC, you own 100% of the company. But if you have more than one owner, you'll create a multi-member LLC. In multi-member LLCs, each member owns a portion of the company.

Initial ownership of a multi-member LLC is typically based on what capital, talent, or other assets people are bringing to the business. Because membership interests in a company are its most valued assets from a control and profit perspective, you'll typically want to relinquish as little ownership interest in your LLC as possible.

For example, instead of giving away membership interests, you can offer alternative compensation arrangements such as:

• commissions
• wages
• salary, and
• profits interests.

However, note that it's standard for investors to be members because they're putting up the money and have the most financial risk. (For more information on equity investors, read our article about raising private money for your business.)

The number of membership interests given to each member will usually be based on that member's proportional contribution to the LLC. After the members negotiate their ownership amounts, each member's membership interests should be reflected in the operating agreement.

How Can My LLC Be Managed?

Management of the LLC can take many different forms, particularly if there are multiple members who are investors. Generally, the management of an LLC will fall into one of the following categories:

• You're the sole member, with no investor, and you fully manage the company.
• The LLC has multiple members (possibly including an investor), but all the members agree that one person manages the company.
• The LLC has multiple members (possibly including an investor), and all the members agree that one person manages the company. But the managing member needs the other owners' consent before taking certain actions that are outside the ordinary course of business—for example, borrowing money, selling the company, and declaring bankruptcy.
• The LLC has multiple members (possibly including an investor), and all the members agree to manage the company together—perhaps by forming a board of managers (which is similar to the board of directors of a corporation).

Generally, if all of the LLC's members participate in running the business, the LLC is considered to be member-managed. If only some LLC members (and sometimes nonmembers) are chosen to manage the company on behalf of all the owners, then the LLC is considered manager-managed. To learn more about these two management structures, read our article on member-managed vs. manager-managed LLCs.

Again, after you and the other members negotiate the final management arrangement, the terms should be specifically written out in the operating agreement so that everyone is clear of their rights.

Can I Convert My LLC to Another Business Structure?

Generally, you can convert an LLC to another business structure (and vice versa), as long as you meet that business structure's requirements. But some states could restrict which entity conversions they allow. So you should check with your state's business formation authority—usually the secretary of state's office or corporations division—about which entity conversions you can make.

One of the most common conversions is from an LLC to a corporation. You'll need to follow the rules and procedures laid out by your LLC's operating agreement if you have one. For example, your operating agreement might say that a majority vote by the LLC members in favor of conversion is required for you to convert your LLC. If you don't have an operating agreement or your agreement doesn't address entity conversions, then you'll need to follow your state's laws.

Talking to a Business Attorney

If you have experience starting and running small businesses, you could likely create one yourself or with the help of your co-owners. But if you don't have much experience with the legal side of starting or running a business and you have questions specific to your circumstance, you should talk to an attorney with LLC experience. They can help you file formation paperwork with your state, as well as advise you on the best management structure for your business. They can also help you draft your operating agreement and help you decide on the best plan for establishing ownership interest in your company.