ABA Family Legal Guide

Forming and Operating a Small Business

Types of Business Organizations

Limited Liability Companies

What is a limited liability company?

A limited liability company (LLC) combines certain attributes of a corporation and a sole proprietorship or a partnership.

Since an LLC is not a corporation, it provides the flexibility of organization of a proprietorship or a general partnership--you don't have to have shareholders, directors, and officers, to say nothing of the mandatory meetings. And it has the same pass-through taxation that sole proprietorships and partnerships do.

But because an LLC protects against individual liability, it can give you the same protection as the shareholders of a corporation enjoy. As an owner of an LLC, you won't be at risk for more than the money you invested--creditors won't be able to come after your personal assets.

An LLC is attractive to entrepreneurs because of the combination of flexibility, limited liability, and avoidance of the two-tiered tax on C corporations.

Other features of LLCs make them attractive. First, the owners (called members) can have full or limited management rights, as desired. They don't have to adopt the three-tiered management structure of shareholders, directors, and officers, as do corporations, though in fact some choose to. The members of an LLC can take an active part simply and directly.

Second, as a member, you have some protection against unacceptable new members becoming involved in managing the business. Under many state LLC laws, members can transfer their financialrights in an LLC freely, but their right to participate in the governance may not be transferred without the consent of the remaining members. (Of course, the flip side is that this restriction may make it harder to dispose of your ownership interest in an LLC than your shares of stock in a corporation.)

Third, you and the other members can be creative in how you agree to divide profits and losses. There's no requirement that these be divided according to the percentage of ownership, but there is such a rule for corporations.

Want some more advantages? There are no restrictions on the number or type of people who can be members of an LLC, or on the types of ownership interests. That means LLCs can be used in far more situations than S corporations, which can have no more than seventy-five shareholders, all of whom, with the exception of certain types of trusts and estates, must be U.S. citizens or resident aliens. Your LLC, for example, can have a nonresident alien, a corporation, a partnership, or another limited liability company as a member.