Understanding LLC

The words “Limited Liability Company”, or LLC appearing at the end of a business’s name indicate to others that the liability of the owners of the business is limited to the extent of their investment in the business. In simple words, the implications are that if such a business files for bankruptcy, the owners can continue to hold their mansions and wealth, while the creditors might have to forego parts of amounts loaned by them to the business. Even the credit scores of owners cannot be affected in such circumstances. These are the reasons for recent increase in numbers of LLC businesses.

LLC and Corporations are different, though there are plenty of similarities between the two. The concept of limited liability as mentioned above, is of course, common. However, a business becomes a Corporation when it is incorporated under corporate law. The process results in some restrictions being imposed on the business now called Corporation. There are several stipulations, which small and medium sized businesses may have difficulty in complying with. The most prominent among these stipulations relate to borrowing powers. The LLC status lets the businesses avoid all these complicated steps and restrictions.

The advantages that LLC businesses are given are defined considering that the LLC is formed by a group of individuals. However, even single individual can form an LLC. Therefore, individuals can do business either as sole proprietors, or as an LLC. Formation of LLC is again a cumbersome procedure, which can be avoided, if the individual/owner has no plans to borrow or enter into any risky propositions.

The prevailing economic conditions have made people extremely averse to borrowing. In such circumstances, LLC offers a way out. This is because in worst-case scenario, anything that the business owes to creditors can only be recovered from the assets of the business. Effectively, the business is considered to be a different entity from its owner/s, and therefore, the assets and liabilities of the business have nothing to do with assets and liabilities of owner/s. Likewise, assets and liabilities of the owner/s, including bad or good credit score of the owner does not translate into anything negative or positive for the LLC business.

So why does a business need to borrow? Borrowing may be necessary in the initial stages of any business, to capture a larger market share, especially to be a step ahead of competitors. Borrowing allows businesses to invest in new technologies, increase their workforce, increase their production and ensure that the product is always available on retail shelves, offer products at lesser price than that of competitors and thereby capture more of market share, take advantage of discount on raw materials available in market at any point of time, and so on. Businesses borrow at lesser rate of interest, and earn higher profits from it. This is called financial gearing. The more the business borrows in comparison to the owner’s equity, the more highly geared it is termed. Highly geared companies make more profits, and are also at greater risk of entering into debt trap. Ability to borrow without severe consequences can at least bring in equality if not more amongst businesses forced to compete with established and larger businesses.

Effectively, LLC concept allows business owners to take the risk, without fearing repercussions.

Disclaimer: The information above is not a substitute for legal advice. Please consult your lawyers before taking any action.

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