What is an LLC? – Master of Accounting Degrees

It could be argued the explosion in small business activity and the resulting beacon of entrepreneurial activity that shined so brightly in the 1980s was due to an innovative new business structure called a Limited Liability Company that started in Wyoming and changed the world by the time it got to Delaware.

The purpose of the new entity was to combine the best features of a partnership and a corporation into a lightweight legal framework to provide both corporations and individuals a way to get pass-through tax treatment and liability protection at the same time.

Six or a Half Dozen?

One of the biggest problems faced by small business owners and especially those who are just starting out is how to escape the sole proprietor trap. When an individual owns a company, they have few options for raising capital and far too many ways to end up beset by legal troubles, to say nothing of their vulnerability when it comes to trade secrets, intellectual property and enforcing contracts.

The American Bar recognized what others already knew. What these new companies needed was a way to avoid the legal tangles common to partnerships and a way to simultaneously retain the simplified pass-through tax status they would otherwise have with a corporation. The intractable problem was the simple Subchapter S corporation made it hard for businesses to grow while general C corporations couldn’t take advantage of the simpler tax treatment. It put economic growth west of the rock and east of the hard place until a light bulb went on in Wyoming in 1977.

Partnership Inc.

The basic innovation of the Limited Liability Company is the combination of all the best parts of a partnership with all the best parts of a corporation, with only a few of the less popular features. In an LLC, a managing member can have as little as 1% of the equity while retaining executive authority over the business. This is dissimilar to the corporate model, where a chief executive serves at the pleasure of a board of directors elected by shareholders.

Meanwhile, Forbes notes all members of an LLC benefit from the same kind of liability shield enjoyed by shareholders in a corporation. If legal action commences, it is the LLC that acts as plaintiff or defendant, leaving the personal assets of the membership out of any potential liability at issue. This is vitally importan because it is the only thing that allows any company to set long-term plans and grow beyond its book value.

Is an LLC the Right Choice?

Ultimately, the type of business entity for a particular company depends on the activities of the business itself, and the company’s plan for capital formation and growth. These are the kinds of questions it pays to pose to a qualified financial advisor or business attorney, as they will have detailed answers that highlight all the options.

This new entity is a powerful option for any business owner interested in moving beyond the traditional boundaries of a sole proprietorship and exploring the financial advantages of pass-through tax treatment and easier capital formation. At this point, nearly every state has some kind of LLC option for new businesses. A Limited Liability Company is something every entrepreneur should consider.