A limited liability company (LLC) is a corporate structure whereby the members of the company cannot be held personally liable for the company’s debts or liabilities. Limited liability companies are essentially hybrid entities that combine the characteristics of a corporation and a partnership or sole proprietorship. While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of partnerships.
Although LLCs have some attractive features, they also have a number of disadvantages, especially in relation to the structure of a corporation. A LLC has to be dissolved upon the death or bankruptcy of a member, unlike a corporation, which can exist in perpetuity. Also, a LLC may not be a suitable option when the objective of the founder is to eventually become a publicly listed company.
The primary reason an LLC is selected as an ownership structure is to limit the principals’ personal liability. An LLC is often thought of as a blend of a partnership, which is a simple business formation of two or more owners under an agreement, and a corporation which is afforded certain liability protections. An LLC is a more formal partnership arrangement requiring articles of organization to be filed with the state. An LLC is much easier to set up than a corporation, and it provides more flexibility along with the protection. However, creditors may be able to pierce the corporate veil of an LLC in cases of fraud or when legal and reporting requirements haven’t been met.
The primary difference between a partnership and an LLC is that an LLC is designed to separate the business assets of the company from the personal assets of the owner, which has the effect of insulating the owners from the LLC’s debts and liabilities. An LLC functions similar to a partnership in that the profits of the company pass through to owners’ tax return. Losses can be used to offset other income, but only up to the amount invested. The LLC only files an informational tax return.
In terms of the sale or transfer of the business, a business continuation agreement is the only way to ensure the smooth transfer of interests when one of the owners leaves or dies. Absent a business continuation agreement, an LLC must be dissolved in the event of a bankruptcy or the death of a partner.