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 ofpartnerships.
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.
Reasons for incorporating a Limited Liability Company
- Personal Asset Protection
Both Companies and LLPs allow owners to separate and protect their personal assets. In a properly structured and managed company, owners will have limited liability for business debts and obligations.
- Reduces Personal Liability
Incorporated entity is a separate body from the one or ones who own it. Therefore, when an incorporated entity is sued, there are provisions in the law to protect the owners (shareholders) and mangers (officers and directors) from personal liability. Once you do business with the public or have even one employee, you are wide open to legal liability. An incorporated entity can provide a legal shield between your business life and your personal life.
- Separate Legal Entity Status
An incorporated business entity is a separate legal entity from that of its owners and managers. The persons who own and manage the incorporated entity are not directly liable for the acts and deeds of the entity unless there is a violation or misuse of their fiduciary position within the entity. The incorporated entity is capable of owning funds and other properties in its name. The entity will be the owner of all the property vested with it. Being a legal body in the eyes of the law, a Company or LLP can sue in its name and be sued by others.
- Adds Credibility
An incorporated entity has greater credibility in the eyes of many customers and lenders than does a sole proprietorship or partnership. When you have taken the step to incorporate your company, it is perceived that you have long-term plans for your business. Because of the added trust, this may increase the likelihood that customers and lenders will be willing to part with their money.
- Protection of Name
Registering a business gives protection to the extent that no one else will be permitted to register a business with the same name. However, ultimate protection can only be ensured through Trademark Registration
- Deductible Expenses
Business entities are entitled to deduct normal business expenses, including salaries from the revenue before they calculate income for tax purposes
- Raising Capital
There is a greater source of capital available to registered Companies and LLPs than to partnerships or proprietorships. Because the incorporated entities are separate from the owners, people tend to be more willing to invest money without accepting liability or responsibility for company business.
- Transfer-ability of Ownership Or Interest
The shares of the Company and interest in LLP are considered movable properties and are easily transferable subject to law.
- Perpetual Duration
An incorporated business entity continues to live even after the death of its owners.
- Governance and Disclosure Norms
In India, Company and LLP form of organizations are governed by respective Laws. A Company and LLP have to follow various regulatory procedures during the course of their operations and are subject to stringent disclosure norms. Good governance and transparent disclosure of operations add value to the business, thus benefiting the true business owners.