(US commercial law and generally) When you launch a new business startup, one of the most pressing questions you’ll face is how to fund it. While there are many options for business fundraising, one of the most typical is to court outside investors. To pursue outside investments, you will need to make a prudent decision about the legal structure you choose for the business.
For many business owners, this means incorporation. Undoubtedly, forming a Corporation provides easy avenues for bringing in investors, venture capitalists, and beyond. However, Corporations also come with some strict regulatory guidelines, and much administrative overhead.
Alternatively, some business owners choose the Limited Liability Company, or LLC format. An LLC offers much more flexibility, and a lighter regulatory burden, than a Corporation, which makes it an attractive option to business owners not ready to form corporate bylaws or to issue shares. Having said that, the LLC format may also provide some opportunities to bring in investors.
LLCs Defined
The LLC is a popular structure for small businesses, providing a level of personal asset protection that Sole Proprietorships cannot match. Registering a business as an LLC establishes it as its own legal entity, distinct from its owner, which makes it possible to keep business assets and liabilities clearly distinct from personal assets and liabilities.
Generally speaking, LLCs are less burdensome to establish and maintain than a Corporation. They do not have a provision to sell ownership shares, they do not require annual shareholder meetings, and they do not compel the creation of governance documents, such as bylaws.
One of the primary advantages of the LLC is that it allows members to invest confidently in their business, with assurances that their personal or family assets are shielded from litigation as well as from potential creditors.
Attracting Investors: The Strengths of the LLC
There are several ways in which forming an LLC may help attract outside investors.
Limited Liability Protection
Investors gravitate to LLCs precisely because they provide limited liability protection. Investors are more willing to invest knowing their personal assets are not at risk beyond their investment.
Flexible Management Structure
Additionally, LLCs allow for flexibility with regard to how the business is managed. Investors often find this appealing because they can negotiate specific management rights and responsibilities as part of their investment terms. They can be passive investors or actively involved in the management, according to their preference.
Pass-through Taxation
LLCS offer their members pass-through taxation, which means members declare profits and losses on their personal tax returns. This allows LLCs to avoid the kind of double taxation that corporations face (taxation at both the corporate level and again on dividends to shareholders), which is a huge plus for investors.
Ease of Transferability
LLCs provide easy ways to transfer ownership interests or to enlist new members. This flexibility can be appealing to investors who plan to sell their interest in the future, or even to include their investments as part of their estate plan.
Professional Credibility
Registering your business as an LLC also enhances its credibility and professionalism in the eyes of investors. It shows that the business is serious about protecting its members and conducting itself in an organized and careful manner, something that builds investor confidence.
Attracting Investors: LLC Limitations
For all of the strengths of the LLC, particularly with respect to attracting outside investors, it should also be noted that there are some limitations. Indeed, the LLC is generally regarded as not being as strong as the Corporation for courting external investments.
There are a handful of reasons for this.
- Institutional investors are typically much more familiar with Corporations, and thus feel more comfortable investing in a Corporate environment as opposed to an LLC environment.
- Corporations also have more mechanisms available for equity financing. Specifically, they can issue different types of stocks, something that LLCs cannot do.
- With a Corporation, you have the opportunity to take your business public with an IPO, courting investors on a broader scale. LLCs have no such provision.
- Corporations usually offer more structured and stable exit strategies for investors, something that LLCs cannot match.
Even given these limitations, the LLC format can be a fruitful option for attracting outside investors.
Other LLC Financing Options
Another note for business owners: Forming an LLC provides other ways of fundraising, above and beyond outside investment.
Specifically, forming an LLC generally provides greater opportunity to pursue business loans and lines of credit. Such business financing is not as attainable to Sole Proprietors, but the enhanced credibility of the LLC can curry favor with banks and other lending institutions.
And while this is hardly the same as equity fundraising, it can provide small businesses with a needed infusion of cash flow.
Registering an LLC: Quick Tips
The steps for registering an LLC can vary from state to state, which means to register for an LLC in Wyoming looks different than it might in California. With that said, some general steps include:
- Choosing the state in which you wish to register (typically the one where you are located and generating income).
- Appointing someone to serve as the Registered Agent for your LLC.
- Filing Articles of Organization with your Secretary of State, and paying the required LLC registration fee.
- Creating an Operating Agreement, outlining how your LLC is managed day-to-day.
- Claiming an Employer Identification Number (EIN) from the IRS.
- Maintaining a business bank account, separate from your personal checking or savings accounts.
Using an LLC to Bring in Investors
To grow your business, you’ll need to think in terms of funding. As you consider the prospect of outside investment, determining whether the LLC might be an advantageous structure. And with any further questions about LLC formation or operation, don’t hesitate to meet with a business attorney in your area.
Amanda E. Clark is a contributing writer to LLC University. She has appeared as a subject matter expert on panels about content and social media marketing, as well as topics related to business ownership.
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