When you’re starting a new business, it can feel both exciting and overwhelming. Sure, there’s many aspects to becoming a business owner you can learn along the way. Others, like setting up an LLC, is something you can’t afford to mess up — it can cost you both in lost time and money.
As you’re working towards setting up your LLC, you’ll want to make sure you’ve thought through these six potential mistakes so that you can avoid them.
Choosing The Wrong Entity
There are a few different types of LLCs, the most popular being the single member, multi-member, and an S-Corp, which isn’t actually a type of LLC but rather a tax designation of your LLC (don’t worry, we’ll go over this more later).
Although these three all technically fall under the LLC umbrella, they have distinctive features. Meaning, picking the right type for your business is crucial since it will affect aspects of your business like taxes.
For instance, a single-member LLC is best for someone who isn’t interested in keeping up with a lot of paperwork or corporate formalities, but wants liability protection. This type of LLC will need to file quarterly taxes and profits are passed on to the owner as taxable income. When you’re a single member LLC, you’re taxed like a sole-proprietor. Unless you ask the IRS to change your tax treatment to an S Corp.
S-Corps are still LLCs, but are no longer taxed as a sole proprietorship and may be best suited for those who earn more than $80,000 in annual profit and want to have some form of tax savings. As an S Corp, you’ll have to adhere to different tax deadlines and regulations, such as paying yourself a salary and regular payroll taxes.
If you’re unsure of what type of entity you should form, it’s best to consult an experienced professional who can help you determine the best choice.
Incorporating in the Wrong State
Most business owners incorporate in their state, since it makes the most sense to have a business license where they live. However, some business owners want to register in another state because there may be “better” legal and tax benefits — popular states include Delaware, Wyoming, or Nevada.
While this isn’t necessarily false, incorporating in other states tends to make the most sense for larger businesses. Smaller businesses or solo business owners who do might have to go through more hoops like filing more paperwork and paying more fees, both for the state you live in and where your business is incorporated. You’ll also need to make sure you have a registered agent for where your business resides and the state you live in.
All this to say: these extra hassles may not be worth it for the supposed savings. There are plenty of ways to optimize your business taxes — this is where a tax professional can come in handy — even if you incorporate in the state you live in.
Forgetting to Keep Your LLC Compliant
Setting up an LLC isn’t a one and done affair. After submitting your initial paperwork, you’ll need to ensure that your LLC is compliant after it’s formed. Otherwise, you may run into issues such as piercing the corporate veil (aka where business owners are personally liable) and your personal assets are at risk.
Some actions you may need to do you protect yourself and your business include:
- Making sure you use your business name in all business documents
- Submit your annual report or statement as per your state guidelines
- Submit an articles of amendment as need if there are key changes to your LLC
- Ensuring your business funds are separate from your personal ones
To find out what the requirements are for your state, speaking with a legal professional or contact the state’s secretary of state.
For those who are setting up LLCs with a partner, getting the right types of agreements in place ensures that you can both protect your business relationship as well as the business itself. Two of the most important ones include an operating agreement and a buy-sell agreement.
An operating agreement lays out exactly how the business needs to be managed, how much of the company is owned by each member, what their responsibilities are and how to handle profits and losses. Solo business owners may need one to comply with state requirements.
A buy-sell agreement will cover what should happen to the business if a member decides to stop work, is incapacitated or passes. Addressing possible future scenarios is helpful to avoid any issues and to remain in compliance.
Incorporating Without Required Licenses
Depending on your business and your state, you may be required to get some type of local, state or federal license. This is not the same as setting up a corporation or LLC. For example, those who want to work as financial advisors may need to check with their state to see what kind of license they need. Most business licenses aren’t too costly — it’s better than paying expensive fines if you operate without a required license.
Failing to Get the Right Kind of Legal Assistance
There’s nothing wrong with filling out the necessary forms to file an LLC yourself. For single-member LLCs that have simple requirements, like being 100% self-funded and incorporating in their own state won’t have many issues. However, for those who are considering S-corps, seeking legal assistance may be beneficial.
For instance, if you decide to do business in multiple states, you’re starting a business with a partner or have other complex situations, seeking professional advice can prevent issues down the line, such as navigating vague operating agreements during a dispute.
It’s understandable to be concerned about the costs of hiring a legal professional. After all, you may be just starting your business and want to earn money before investing any into the business. However, this upfront expense counts as a business write-off, and getting sound advice can save you money.
There are also alternatives to hiring a lawyer. Services like Collective can set up your LLC for you and help you navigate tax and legal paperwork.
Using Random Legal Documents Found Online
The internet houses a treasure trove of information (it’s how you find this article!) and there are plenty of resources out there to help you start and grow your business. One such resource are templates and forms. Sure, it can save you time and money from having an attorney draft one up, and in many cases it’ll do just fine. However, using these forms can get you into hot water.
For instance, I was involved in a business partnership with someone in another state, we downloaded a random operating agreement template online giving us equal ownership rights. However, due to varying factors such as the types of assets we brought in, we wanted different ownership percentages. Had we used the form without looking at it twice, it could have been disastrous.
Again, there’s nothing with using templates found online but you need to review them before adopting them into your own LLC. If there’s any verbiage you’re unsure about or you want to ensure the documents are rock-solid, asking an experienced legal professional is helpful.
Starting a business is tricky enough without having to worry about backtracking because you’ve chosen the wrong business entity or didn’t keep records so you remain compliant in your LLC. That being said, once you’ve done the upfront work of figuring out how to best structure your business, submitting the necessary paperwork can be relatively easy.
After that, it’s making sure to keep your business compliant — that’s where having systems comes into play. Good luck, we’re rooting for you!
