The Limited Liability Company (LLC) has become a hot business structure in the startup world. Savvy small business owners often opt for this structure over a traditional corporation, as the LLC offers personal liability protection without the red tape, paperwork and formalities that can be burdensome for a young startup, small business or solo entrepreneur.
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However, many small business owners are surprised to know that there are choices for your LLC. From a single-member LLC to a multiple-member LLC, member-managed LLC to manager-managed LLC, how do you know what’s right for you?
If you’re considering a legal structure for your business, read on to explore the differences between the types of LLCs.
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Single Member LLC or Multiple Member LLC
The difference here is fairly straightforward. As the names imply, a single member LLC (SLLC) has a single owner, while the multi-member LLC has multiple owners.
For example, Nancy started a social media consulting business; she’s the sole owner, but plans to hire a few account managers and other employees. In this case, Nancy could form an SLLC because income from a single member LLC isn’t divided (as it would be for a partnership or if there were multiple owners of the business) and there are no separate taxes to file with the IRS. The IRS treats an SLLC just like a sole proprietorship. But note that LLCs can also choose to be taxed as a corporation.
Now if Nancy decided to launch the consulting business as a joint venture with a colleague, there would be two owners, and they could form a multi-member LLC.
Member Managed LLC or Manager Managed LLC
Once a multi-member LLC is formed, you’ll need to set up your desired structure in the LLC operating agreement: member-managed or manager-managed.
A member-managed LLC is run by the owners of the company. This is the simplest structure and means that every owner has the authority to act on behalf of the business (i.e. take out a business loan, negotiate contracts and handle other financial and operational tasks).
Using Nancy and her social media business as an example, let’s say that Nancy and her colleague Frank launched the business. Both plan to be active participants in the business, with Nancy handling client relations and Frank managing the administrative aspects. Since they both will have direct involvement in the business, a member-managed LLC will probably make the most sense for them.
Now let’s say that Nancy and Frank are launching their consulting business but need some financial support to get the business off the ground. A few of their friends and family pitch in and invest in the business. In this case, the manager-managed LLC would probably be optimal.
A manager-managed LLC is typically used when there are passive members in the LLC, such as investors who aren’t actively involved in the business. With a manager-managed LLC, the LLC members elect managers who have the authority to operate the business. In our scenario, Nancy, Frank, investing family and friends are all members of the LLC. Then, the members elect Nancy and Frank to be managing members. Nancy and Frank are responsible for the day-to-day operations, while the non-managing members remove themselves from the direct operations of the business.
In most states, an LLC is member-managed by default. That means that if you don’t specify management structure in the formation documents you file with your state, your LLC most likely is member-managed.
Domestic LLC or Foreign LLC
In this case, domestic or foreign refers to the state where the LLC is created and operates. A company that is registered in Michigan and does business in Michigan is operating as a domestic LLC. If the same company does business in Illinois (and has a physical presence there), it is operating as a foreign LLC in Illinois.
This situation commonly comes up when an LLC is created in states with business-friendly tax laws but does business in its home state. It can also occur when a business starts expanding into other states. A foreign LLC is required to register with the Secretary of State in the foreign state (as well as meet the regulatory and tax requirements of the foreign state).
Be aware that just having a client or selling to customers in another state doesn’t necessarily mean you’re operating in that state and must register as a foreign LLC for that state. While exact requirements vary state to state, operating in a state generally means:
- Having a bank account in the state.
- Selling in the state through some party directly tied to the LLC (a distributor or sales rep).
- Owning property in the state.
- Having offices, owning facilities or holding regular meetings in the state.
Do Your Homework Upfront
The LLC structure is a great option for young and small businesses that don’t want to be burdened with excessive paperwork and requirements. Once you understand the different types of LLCs, it should be relatively straightforward to determine which flavor is right for you. As with any legal matter, don’t delay. The sooner you get your business structure squared away, the better.
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