One of the most common questions I’m asked is how to know when to start an LLC. The short answer is, it depends. There is no definite time to start an LLC that’s relevant to all businesses. Some businesses could operate as a sole proprietorship forever without any issues. Others should form an LLC right away. Though there are no hard and fast rules to know when it’s time to start an LLC, there are some things to consider so you can know if it’s the right time for your business.
A lot of people think there is a certain income threshold you need to hit before you should consider starting an LLC. And that can be a factor, but it’s not a deciding factor. This article will give you some things to consider to know when it’s time to start an LLC for your business.
What is an LLC?
LLC stands for limited liability company. It is a business structure formed at the state level. One of the great things about an LLC is it helps protect your personal assets from business liabilities. So, if your business gets sued, you personal assets aren’t at risk.
If you would like to know more about LLCs, check out this post for more information.
Though an LLC can protect your personal assets, it is critical to have an Operating Agreement to maintain this protection. You can read more about Operating Agreements here or if you know you need one for your LLC, check out my shop for an easy to customize template.
How do you know when to start an LLC?
I don’t think there’s any business that wouldn’t benefit from operating as an LLC (or other business entity), but there are additional expenses involved so they’re not something everyone wants until it’s absolutely necessary. If you know you want an LLC for your business, there’s usually no reason not to do this right from the very beginning. But, if you’ve been running your business as a sole proprietor for a while and wondering if you should switch over to LLC, read on.
If you aren’t sure and want someone to guide you in the decision, reach out to a local attorney licensed to practice in your state. Though I can help you set up your LLC once you’ve made the decision, I cannot make the decision for you.
How risky is your business? How likely are you to be sued?
Every business will have different risk factors for being sued. In some industries, this is more common than others. For example, if you create a physical product that could possibly injure someone, you may be at a higher risk than someone who has a lifestyle blog. Another thing to consider is what damages (legal injury-can be monetary, physical, etc.) think about what damages you may be liable for. If your likelihood of being sued and the amount you would be sued for is low, you may not need an LLC for your business.
How risk averse are you?
Along with how much potential risk you have, you need to consider how risk averse you are. If you are the type of person who generally doesn’t worry about things and doesn’t think anything bad will happen, then you may be willing to take the risk that your business could potentially get sued and put your persona assets at risk. On the other hand, if you tend to worry and not want to take a chance of putting yourself at risk, an LLC is a good choice for you.
How much money are you making?
Many people think there is a certain income threshold where an LLC is either required or recommended. This isn’t necessarily true, but how much you are making is a factor to consider. Depending on where you live, starting and maintaining an LLC will cost a few hundred to a thousand dollars. If you aren’t making enough money in your business to cover that, plus your other expenses yet, then you may not be ready to start an LLC. That being said, just because you aren’t making money doesn’t mean you aren’t at risk of being sued.
Will it make others take your business more seriously?
Like it or not, perception does matter. For some business types, operating as a sole proprietor and/or in your own name is fine, but for others having that “LLC” at the end of your business name will make others take you more seriously.
Will it make you take yourself more seriously?
It’s even more important that you take your own business seriously. If you are stuck in the hobby or super-small business mentality, it’s going to be hard to grow your business to the level you want. If forming an LLC will make you work harder and be more likely to see your business as legit, then it’s worth it.
Do you make more money than you need to bring home each year?
As a sole proprietor, any money your business makes (less expenses) is going to be taxed on your individual return. Which may be fine for a while. But, once you reach the point where your business is making more than you need to bring home as income, you may want to keep some money in the business. This isn’t possible as a sole proprietor, unless you are actually using the money to purchase things.
Most LLCs are taxed as sole proprietors. But, as an LLC you have the option to be taxed as an S-Corp. Once you reach a certain income level, this can be a big tax savings. You can talk to a CPA to see if this is the best choice for your business. If you’d like to know more about S-Corps, check out this article.
Do you want to scale your business?
If you want to grow your business, this can be hard to do as a sole proprietor. It’s not impossible, but it’s much easier to scale an LLC.
Do you need investors?
LLCs are not the easiest entity type to get investors for, but it’s going to be very hard to get anyone to invest in a sole proprietorship. If you need to raise capital, you should consider forming a formal business entity.
If you aren’t sure when to start an LLC, ask yourself these questions:
- How risky is your business? How likely are you to be sued?
- How risk averse are you?
- How much money are you making?
- Will it make others take your business more seriously?
- Will it make you take yourself more seriously?
- Do you make more money than you need to bring home each year?
- Do you want to scale your business?
- Do you need investors?
Though I don’t think an LLC, or other formal business entity, is necessary for all businesses, I do think all businesses could benefit in one way or another. Having an LLC is relatively inexpensive (for a business), it’s easy to manage, and it can help protect your personal assets.
If you aren’t ready yet, don’t worry. It’s usually easy to make the switch from sole proprietor to LLC down the road. If you are ready to form your LLC, check out this guide to DIYing your LLC. Or, if you would like help, email me at andrea@YourEntrepreneurSchool.com for more information on my entity formation service.
Disclaimer: This site, and all information contained herein or through communication with me, is intended as legal information only. I am an attorney, but I am not your attorney, so nothing on this site, nor any communication with me, shall create an attorney-client relationship. I am not liable for damages or losses based on any action taken, or inaction, based on the information contained on this site. All areas of the law are fact specific and there is no substitute for legal advice from an attorney licensed in your jurisdiction who is familiar with the specific facts and circumstances of your situation.