To answer this question, first let’s answer what an entity is.
What is an Entity?
An entity is a business organized according to state law to limit the liability of the owners. Entities can be corporations, limited-liability companies (LLCs) and limited partnerships (LPs). All provide much greater asset protection when compared to a sole proprietorship or general partnership.
An entity is a separate legal being. It is the ‘separateness’ of an entity which protects you – the entity’s owner – from unlimited personal liability. Without that separation, if an angry customer sues you, any assets you own such as your house, car or bank account can all be taken should a judgment be found against you.
It’s critical to know that an entity can’t protect you if it is not set up right at the start. You can’t set up a corporate entity while you’re being sued and expect it to protect you. Furthermore, it can’t protect you if you don’t properly maintain your entity over the long term.
Maintaining an LLC or Corporate Entity
In order to maintain the limited liability protection provided by corporate entities, you must follow certain requirements called “formalities.” These include:
- Filing statements,
- Paying annual fees,
- Maintaining a resident or registered agent to receive all legal documents,
- And keeping corporate minutes
Failure to follow these formalities can result in personal liability to officers, directors and shareholders.
When Should You Use an LLC?
A limited liability company (LLC) is a great entity for a beginning business that:
- wants to invest in assets that will appreciate over time;
- is intended to be an estate-planning vehicle to transfer wealth to the next generation;
- wants its owners to hold their interests in the names of other entities or trusts;
- wants to be able to sell ownership interests all over the world;
- wants to provide its owners with flow-through taxation;
- wants to divide up the profits and losses in ratios other than strict ownership percentages;
- wants to protect its assets from creditors;
LLCs are one of our favorite entities to use. They provide both the limited liability protection found with corporations, as well as the flow-through taxation of a partnership. They allow you to divide up profit and loss allocations among the owners in varying ways — and not based strictly on ownership percentages, as is required in C and S Corps. Ownership may be held by individuals, corporations or trusts, and there are no restrictions on where owners live.
Annual meetings are not required but are strongly recommended, both as a good method of communication between the Managers and the Members, as well as establishing that the LLC is a distinct, stand-alone entity. That last point is important, as when corporate formalities are not followed creditors may attempt to pierce the veil of protection of LLCs as well as corporations.