Limited Liability Company Definition, Formation and Types
Table of Contents
- Limited Liability Company Definition
- Concept of Limited Liability
- Characteristics of Limited Liability Company
- Difference between Limited Liability Company and Limited Company
- Types of Limited Liability Company
- Sources of Finance for Limited Liability Company
- Formation of Limited Liability Company
- Advantages of Limited Liability Company
- Disadvantages of Limited Liability Company
Limited Liability Company Definition
It is a legally recognized company that limits the liabilities of the members to only their capital contribution and tax on profits is imposed on owners’ income. Limited liability company combine certain characteristics of partnerships and corporations to operate successfully in domestic and foreign economies.
LLCs are among many business forms that exist around the globe today. Some choose to expand beyond their domestic markets and enter foreign ones. These expansionary exploits may be expensive for LLCs just like any other business. Owners are compelled to protect their LLC from eventualities such as debts and other liabilities that the entity’s assets may not fully cover.
Concept of Limited Liability
Limited liability is a condition that has allowed businesses to develop large-scale operations. It protects prospective investors and members from suffering a personal loss if the business incurs losses beyond what it can successfully pay off by selling its assets. It assures investors of protection from personal loss beyond their capital contribution. The concept of limited liability allows business structures that incorporate limited liability to access capital from investors who may be unwilling to venture into risky businesses.
Characteristics of Limited Liability Company
1. Separate legal entity
A limited liability company has a separate existence from its owners and thus is considered to be an artificial person. This gives LLCs privilege over a partnership to raise capital. A limited liability company can transact independently, make decisions, sue, and sue in its name.
2. Perpetual existence
Unlike other business structures such as a partnership, a limited liability company can continue operations even after a member dies or becomes incapacitated or bankrupt. Professional management may change, but the company would still be operational unless stated otherwise.
3. Limited liability
Members of limited liability company enjoy protection from incurring losses beyond their capital contribution. Even though a Limited Liability Company can lose its assets in loan default, such losses do not apply to members’ assets.
4. Flexibility in taxation
The business income of a Limited Liability Company is not taxable. Instead, taxation applies to the profit share of each member’s income. In the United States, a Limited Liability Company can be taxed either as a sole proprietorship if the member is just a single person or a partnership if it contains more than a single member.
5. Ease of formation
A limited liability company is easy to form and manage since it requires few legal formalities to be brought into existence. It enjoys partnership characteristics, ways of formation, and the company’s operations.
6. Members acting as owners
The members of a limited liability company can function as its operators or appoint one of them to manage the business on their behalf. The members also have the liberty to employ outsiders who may be highly skilled to control the company’s day-to-day functions.
Difference between Limited Liability Company and Limited Company
Though they may look the same, a limited liability company (LLC) and a limited company (LTD) are differentiated in the following ways:
1. The extent of liability protection
A limited company (Ltd) covers a shareholder from suffering a personal loss in case of liabilities. In contrast, a limited liability company (LLC) covers members from personal loss from some or all liabilities depending on the applied jurisdiction.
2. Selling of shares
A limited company (Ltd) cannot sell shares to the public, while a limited liability company (LLC) can incorporate one or more members into its structure.
A limited company(Ltd) is taxed as a separate legal entity, while a limited liability company (LLC) can be taxed as a partnership or a corporate body.
Types of Limited Liability Company
There are four types of limited liability company:
- Single-member limited liability company
- Multimember limited liability company
- Not-for-profit limited liability company
- Professional limited liability company
1. Single-member Limited Liability Company
As the name suggests, this is a company comprised of only one member. Apple Company was started as a single-member limited liability company. Single-member limited liability company cannot be treated as separate legal entity.
2. Multimember Limited Liability Company
Compared to a single-member LLC, a multimember has more than one member. These can be treated as separate legal entities from their members. Examples include Facebook and Microsoft, which started as multimember limited liabilities companies.
3. Not-for-profit Limited Liability Company
These companies do not entirely exist to generate profits and can enjoy no tax benefits with other advantages like limited liability and flexibility, as seen in corporations and partnerships.
4. Professional Limited Liability Company
Professional services providers like lawyers and doctors can form this type of company.
Sources of Finance for Limited Liability Company
The company can issue out shares to the public to amass the authorized share capital needed to start the venture. These can either be ordinary shares or preference shares.
2. Retained profits
A portion of the retained profits may be plowed into the venture to run the business.
3. Loans and overdraft
Banks may give out loans to these ventures as soon as they provide collateral and charge interest on the loans borrowed.
Banks may allow account holders to withdraw more than they have in their accounts and charge interest on the money borrowed more than available in the account. This is called an overdraft.
4. Leasing of property
When the cost of an asset is high, the company may choose to lease the asset, meaning they enter a contract to use the asset for a specified period at rent. The ownership of the property is not transferred.
Formation of Limited Liability Company
The following steps are crucial in forming a limited liability company:
Step 1: Choose a suitable name
A name is crucial to starting any venture. The name should emulate the business venture or be unique to the business itself. It should not have a name already registered, obscene, or affiliated with any state-owned organization. The name should also comply with guidelines for choosing a name in whichever state it is registered in.
Step 2: Choose an agent
An agent to represent the company is important. An agent will be responsible for collecting the relevant papers and documents, subpoenas, and suits and presenting them to the relevant recipients. Some companies provide agent services at a relative cost.
Step 3: Prepare a limited liability company operating agreement
An operating agreement is a document drafted by the members that show how the company will be managed and run. It acts as the memorandum of association and contains vital information on dividend sharing, profits appropriation, holding of meetings, and rights and responsibilities of members toward the venture.
Step 4: Fill all organization documents with the relevant authorities
The articles of association and other relevant documents are then filed with the registrar for official acknowledgment and proofreading.
Step 5: Get certificate of incorporation
A certificate of incorporation or registration is then issued by the relevant authorities to ascertain the business existence of the company. The newly formed venture is now allowed to commence operations at will.
Advantages of Limited Liability Company
1. Limited liability
The members can only suffer loss to the tune of their capital contribution to the firm without their assets being touched.
2. Few legal formalities
Like partnerships, they require very few legal avenues to start their operations and are not big on paperwork.
3. Perpetual existence
A limited liability company has a perpetual life unless stated otherwise in the articles. This ensures remunerations for the members and a reliable source of income.
4. No double taxation
Allocated profits in a limited liability company are taxed only once on the tax income of an individual member.
5. Flexibility in sharing profits
In a limited liability company, members are not restricted to sharing profits concerning their levels or proportions. Still, they may choose to share profits differently given the turnout and other factors.
Disadvantages of Limited Liability Company
1. Profits taxed at members peronsla level
Members may have to pay self-employment tax in some other states since they are considered self-employed by being in a limited liability company.
2. Limited liability
Limited Liability Company may have some limits, especially if the company is operating fraudulently and engaging in malpractices.
3. Challenging to settle court disputes
Few formalities make it difficult to settle disputes in Court, especially when the formation was through a gentleman’s agreement.