A beginner’s guide: How to start an LLC

Do you have a business idea that you’re ready to jump on? You may be going through the process of figuring out how to set up your small business and deciding which structure is best for you. Chances are good that you have come across the term “Limited Liability Company” or “LLC” and wondered if that was right for you. We have all the LLC information you need, so keep reading.

What is an LLC?

Let’s break this down. An LLC, or Limited Liability Company, is a popular form of business entity in the United States. It’s a flexible and relatively simple way to organize and run a business while providing liability protection to its owners, who are often referred to as members.

LLCs have several key characteristics to keep in mind, and we’ve outlined them below.

Limited liability

One of the primary benefits of forming an LLC is that, as its name implies, it limits the liability of its members. This means that the personal assets of the members are generally protected from the company's debts and legal liabilities. Meaning that in the event someone sues the business, only the business assets are at risk. In most cases, members are only liable for the amount of money they have invested in the LLC, although there are very specific requirements for this.

Flexibility

LLCs offer a high degree of flexibility in terms of management structure and taxation. As a member, you can choose to manage the company yourself (or with other members) or appoint a manager or managers to run the day-to-day operations.

Pass-through taxation

Limited liability companies are taxed as pass-through entities by default. This means that the company itself does not pay federal income taxes, but rather any profits and losses "pass-through" to the members of the LLC, who report them on their personal tax returns. This can help avoid double taxation, often associated with corporations.

Limited formalities

In comparison to corporations, LLCs typically have fewer formal requirements. There is no need for a board of directors or extensive record-keeping, which makes them a bit easier to run and maintain.

Limited life span

LLCs could have limited life spans, meaning they dissolve or terminate upon the occurrence of events specified in their operating agreements or articles of organization. This is in contrast to corporations, which can exist in perpetuity.

Ownership flexibility

The ownership structure of a limited liability company varies. LLCs can be owned by individuals, other businesses, or even trusts, providing a wide range of options for ownership as well as investment opportunities.

Steps needed to start your LLC

Step 1: Choose a name

When starting an LLC, choosing a name is a key step in the formation process. Your LLC's name is not only how you'll be known in the business world but also the legal identity under which you'll conduct your business. 

As you work through the creative process of selecting the perfect name, there are some basics you should keep in mind.

First, you should consult your state's business registration agency (usually the Secretary of State's office) to understand the specific naming requirements and restrictions for LLCs in your jurisdiction. It’s important to note that each state may have its own rules and regulations regarding LLC names, and you want to be sure that your name complies with your state's naming conventions. It’s common for states to require that you include "Limited Liability Company," "LLC," or an abbreviation of these terms in the name.

In addition, your LLC's name must be unique and distinguishable from existing businesses registered in your state. Typically, you can easily search a state's business entity database online to check LLC names and see the availability of your desired name.

It’s wise to choose a name that reflects the nature of your business and its products or services. Your name should give potential customers an idea of what your business does.

Try to avoid overly complex or lengthy names. A short and memorable name is generally more effective for branding and marketing purposes. A name that is easy to pronounce and spell will make it easier for customers to find and remember your business.

Keep in mind that some words may be restricted or prohibited in LLC names, especially if they imply a government affiliation or a regulated industry. Check with your state agency for a list of restricted words.

Think about the long-term goals of your business. Choose a name that won't limit your growth or expansion into new markets or product lines.

Of course, in today's digital age, it's a good idea to check the availability of a domain name that matches or is closely related to your LLC's name. This can help with your online presence and branding. If you're not ready to register your LLC immediately but want to secure your chosen name, some states offer name reservation services for a fee. This temporarily reserves the name for your future use.

Before finalizing your LLC name, search online to see if the name is already in use by another business, even if it's not registered as an official LLC. You should also check for trademark conflicts.

And lastly, be sure to seek feedback from trusted friends, family members, or business associates. They may offer valuable insights and suggestions on how your name sounds, any specific emotion or feeling the name invokes, and things like that.

Related: 3 Ways to protect your business name

Step 2: Your LLC operating agreement

Writing an operating agreement for your LLC is a crucial internal document that outlines the governance and operational rules for your limited liability company. Typically it would include several key things, such as the management structure (member-managed or manager-managed), the roles and responsibilities of members and managers, the process for admitting new members or transferring ownership, the allocation of profits and losses among members, voting and decision-making procedures, dispute resolution mechanisms, financial and capital contribution details, and how to handle the dissolution or termination of the LLC.  

Additionally, your operating agreement may specify any specific business rules and regulations that govern the operations of your LLC. There are some states that do not require an official operating agreement; however, having a well-structured one in place helps ensure clarity, minimizes disputes, and provides a legal framework for your LLC's operations. It's a critical document for internal management and is highly recommended for every LLC.

All members of the LLC should sign the operating agreement to indicate acceptance and commitment to the terms outlined within it. Depending on your state's requirements, you may need to notarize the signatures on the agreement for it to be legally valid.

It's important to note that while you can create an operating agreement on your own, it's advisable to consult with an attorney or legal professional, especially if your LLC has complex ownership structures or specific legal needs. Once the operating agreement is drafted and signed, keep a copy on file with your business records, and ensure that all members have access to it. It's also a good practice to review and update the operating agreement periodically to reflect any changes in the business or its ownership structure.

Step 3: Register your business

Once you have selected a name that meets all the legal requirements and aligns with your business vision, you can go ahead with the LLC application to register your company with your state's business registration agency. Be sure to complete all necessary paperwork and pay any required filing fees to officially set up your LLC under that name.

To establish an LLC, you typically need to file articles of organization with the appropriate state agency and pay the required filing fees.

It's important to note that the exact rules and regulations governing LLCs can vary from one jurisdiction to another, so it's advisable to consult with legal and financial professionals when forming and operating an LLC to ensure compliance with local laws and to make informed decisions about its structure and management.

Step 4: An EIN for your LLC

Obtaining an Employer Identification Number (EIN) for your LLC is a relatively straightforward process, and there are several methods you can use to apply. An EIN, also known as a Federal Tax Identification Number, is required for tax purposes and is used by the IRS to identify your LLC.  

The quickest and most convenient way to get an EIN is to apply online through the IRS's website. Visit the IRS EIN Assistant page and click on the "Apply Online Now" link to start the application process.

If you prefer to apply by mail, you can do so by completing IRS Form SS-4, which is the Application for Employer Identification Number. You can download the form from the IRS website or request a paper copy by calling the IRS at 1-800-829-4933.

Obtaining an EIN is typically a free service provided by the IRS, and you should be cautious of third-party services that charge a fee for obtaining one on your behalf. You can always verify the legitimacy of the website or service by checking the official IRS website or contacting the IRS directly.

Step 5: Insuring your LLC

It’s a common misconception that LLCs do not need business insurance because the formation of the LLC protects the owners’ assets. While it’s true that if your LLC is set up correctly and its requirements are meticulously adhered to, it may keep the owners’ personal assets from being attached in the event of a lawsuit. But the assets of the business are still at risk, and that’s where business insurance comes in – even for LLCs.

Insurance requirements for an LLC (Limited Liability Company) can vary depending on the nature of the business, its operations, and the location in which it operates. Here are some common types of insurance that LLCs often consider:

General liability insurance: This is the fundamental insurance coverage for businesses. It helps protect your LLC from financial losses associated with claims of bodily injury or property damage caused by your business's operations. General liability insurance can also cover legal defense costs.

Professional liability insurance (also called Errors and Omissions Insurance): If your LLC provides professional services, such as consulting, legal, or medical services, this insurance can protect you from claims of negligence, errors, or omissions in your professional work.

Workers compensation insurance: If your LLC has employees, nearly every state requires workers compensation insurance to cover medical expenses and lost wages in case of work-related injuries or illnesses.

Cyber security insurance: In an increasingly digital world, this insurance can protect your LLC from losses related to data breaches, cyberattacks, and other cyber risks.

Of course, the specific insurance needs for your LLC will depend on factors like your industry, location, size, and the nature of your operations. Hiscox can help you assess your risks and customize an insurance plan that suits your business needs and budget. Keep in mind that insurance requirements can change over time, so it's important to regularly review your coverage to ensure it remains adequate and up to date. 

Related: 3 Reasons your LLC needs small business insurance

Step 6: Financial needs of an LLC

Keeping accurate financial records for your LLC is essential for managing your business effectively, complying with tax regulations, and making informed financial decisions. 

Unless you are a finance professional, you’ll probably want to consider using accounting software like QuickBooks, Xero, or FreshBooks to streamline your record-keeping process. These tools can automate many financial tasks, including tracking income and expenses and generating financial reports. Another option is to work with a certified public accountant (CPA) or tax professional who specializes in small businesses and LLCs. They can provide valuable guidance on accounting practices, tax planning, and financial management.

It’s important that you maintain separate bank accounts and credit cards for your LLC and personal finances. This separation is crucial for maintaining the limited liability protection of your LLC and for simplifying record-keeping.

Regularly generate financial statements such as income statements (profit and loss), balance sheets, and cash flow statements. These reports provide insights into your LLC's financial health. It’s a good idea to develop a budget and financial forecast for your LLC to set financial goals and monitor your progress toward them.

Make regular backups of your financial data, either through cloud-based accounting software or by saving copies of your data files securely. This safeguards your records in case of data loss or system failures.

Understanding your LLC's tax obligations at the federal, state, and local levels is essential. Ensure that you are collecting and remitting sales tax (if applicable) and filing all required tax returns on time. Be aware of the legal and tax requirements for keeping financial records. In some cases, you may need to keep records for several years.

Maintaining organized and accurate financial records is a key aspect of running a successful LLC. It not only helps you meet your legal and tax obligations but also provides valuable insights into your business's financial performance, allowing you to make informed decisions and plan for the future.

Is a Limited liability company for you?

You’ve just read a tremendous amount of information regarding the pros and cons of setting up an LLC, what steps are involved, timelines, and procedures. It's important to note that while an LLC offers many advantages, it may not be the right choice for every business. The choice of business structure should be based on the specific needs, goals, and circumstances of your business, and at the end of the day, do all your research and then consult with legal and financial professionals to make an informed decision.  

Once you’ve made that decision, Hiscox will be there to help protect your business with the right insurance, whether it’s an LLC, sole proprietorship, non-profit, or corporation. 

Related: How to choose the right business structure
 

Frequently asked questions:

How long does it take to form an LLC?

The time it takes to form an LLC (Limited Liability Company) can vary significantly depending on several factors, including the state or country in which you are forming the LLC, the method you choose for filing, and the efficiency of the filing process. Many states in the United States offer online filing options for LLC formation. When using this method, you can typically complete the process in a matter of days or even hours.  

What are the advantages of forming an LLC over other business structures?

Forming a Limited Liability Company (LLC) offers several advantages over other business structures, making it a popular choice for many entrepreneurs and small business owners. Some of the top advantages of choosing an LLC are limited liability protection to members, pass-through taxation, and flexibility.  

Can I change my LLC's name or convert it to a different business structure in the future?

Yes, you can change your LLC's name and convert it to a different business structure in the future, but the process for each of these changes will vary depending on your jurisdiction and the specific requirements.  

How much does it cost to start an LLC?

The cost to start an LLC can vary significantly depending on the state in which you're forming the company. Generally, the primary cost is the state filing fee, which can range from as low as $40 to $500.