Young startup entrepreneurs can’t afford to let business debts become personal liabilities. The importance (and costs) of LLC standing.
Millennials, as 18- to 34-year-olds are known, are now the generation that makes up the largest segment of the U.S. labor force. One in three workers are part of this 53.5 million-strong cohort.
They’re also entering the prime years for starting new businesses. A 2014 survey of 1,000 millennials by Bentley University found that almost two-thirds dream of launching their own startup.
These “digital natives” grew up surrounded by information technology and recognize its potential to lower barriers to entry. A century ago, automobile entrepreneurs required large factories, long supply chains and many employees.
Today, entrepreneurs can disrupt an industry with a software app. Consider the impact of Uber on the taxi business.
For millennial entrepreneurs, these should be the best of times. The Kauffman Foundation, in its 2015 State of Entrepreneurship Address, reports that millennials are better educated, particularly about entrepreneurship, than past generations.
Roughly a third of 25- to 29-year-olds have a bachelor’s degree. In 2008, U.S. colleges and universities filled more than 5,000 entrepreneurship classes with over 400,000 students.
But the same report notes that new business creation has generally drifted downward since 1978 and remains 27 percent below its 2006 level. Worse, new firm survival rates are down. The Kauffman report’s authors attribute these declines to the lingering effects of the Great Recession and student loan debt. Their conclusion: “Millennials can’t afford to be entrepreneurs.”
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Why You Need LLC Protection
In this environment, entrepreneurs who make it to the startup phase can’t afford to let business debts become personal liabilities. Millennials, who grew up accustomed to 24/7 social media connections, need to be aware of this distinction.
The Internet, email and mobile devices have blurred the boundaries between work and home, the professional and personal. These characteristics make Millennials temperamentally suited for entrepreneurship, but at risk for blurring the lines between business and personal liabilities.
A Limited Liability Company, or LLC, is a legal structure that separates the liabilities of a business from the personal liabilities of its members. An LLC may have a single member or multiple members, which can be individuals, partnerships, corporations or even other LLCs.
LLCs are popular because they offer the liability protection of a corporation but require less record keeping. They also offer flexibility in how business income, which is “passed through” to members, is treated for tax purposes. LLC members pay self-employment taxes (Medicare and Social Security) on the net income of the business. Internal Revenue Service Publication 3042 outlines tax treatment of LLCs. Your accountant can offer further guidance.
For some startups, a partnership, cooperative or corporation may be best, but for most, an LLC is the simplest, least expensive way to protect personal assets. The U.S. Small Business Administration (SBA) offers detailed information on choosing a business structure. Your lawyer can help you decide.
Estimating Your LLC Startup Costs
Budgeting startup costs is essential since running out of cash can be deadly. In a recent survey of more than 100 failed startups, insufficient capital was the second leading cause of failure. Costs vary significantly, depending on your business. Do you need to rent space, or can you work from home? Do you need to hire employees, or are you working solo? Does your business require raw materials, inventory or equipment?
You can manage some costs—lease instead of purchase, buy used instead of new—but others are both unavoidable and variable. While state laws governing LLCs are fairly consistent, filing costs to register an LLC vary dramatically, ranging from just $40 in Kentucky to $500 in Illinois and Massachusetts. That is a more than tenfold difference.
Finding out your state’s fee is easy, thanks to a national map of LLC startup fees posted recently by the online MBA degree program at the University of North Carolina at Chapel Hill’s Kenan-Flagler Business School. The site also lists links to each individual state website. These resources help you prepare for the cost and filing process in your state.
Additional licenses, permits or certifications may be required, depending upon your state, locality and industry type. Different agencies may oversee hairdressers and restaurants, for example. Investigate your business requirements at the SBA’s links to federal and state licensing and permitting agencies.
Related Article: Millennial Movers and Shakers: 9 Businesses Built by Gen Y for Gen Y
The LLC Filing Process
Regulatory details vary by state, but there are common steps that all require to form and file an LLC.
Choose a Unique Name
States require registered LLCs to have unique names, which must include a term like “LLC” or “Limited Liability Company” to make your legal status clear to those with whom you conduct business. Certain words, such as “bank” or “insurance” may be disallowed, since these businesses are prohibited from forming LLCs.
State websites usually provide a searchable database of existing names to ensure your choice is available. Here again, the state-by-state links compiled by UNC’s MBA online program will help you. Your LLC name may differ from your “doing-business-as” name, but you may be required to register trade names with your state, and you should plan to include your LLC name on items such as contracts, invoices and checks.
File Your LLC Documents
The primary LLC filing document is known as “articles of organization.” At a minimum, it lists the business name, registered agent, mailing address and names of all LLC members.
It may require your business purpose and duration. Which agency handles LLC filings varies by state. It may be the Secretary of State, Department of Commerce or Division of Corporations. Use the links mentioned earlier to locate your state agency.
Some states require a separate “operating agreement,” similar to corporate bylaws. Operating agreements are a good idea in any case. They specify each member’s percentage interest in the business, how profits and losses are allocated, and what happens if a member leaves the business. The SBA offers advice on what to include. Without an operating agreement, single-member LLCs in particular, are more vulnerable to lawsuits seeking to convert business debts to personal liability.
Announce Your New LLC
In some states, you must announce your LLC filing in a newspaper. A local SBA office can advise you about this requirement. Your local newspaper can quote rates for public notices published in its classified ad pages.
Millennial entrepreneurs today enjoy educational and technological advantages but face an uncertain economy, rapidly changing markets and higher startup failure rates.
Shielding personal assets from business liabilities is crucial. While forming a Limited Liability Company cannot provide total protection, it offers substantial insurance and peace of mind for relatively small additional cost and effort.