7 LLC Formation Mistakes and How You Can Avoid Them

Growth Hacks

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The birth of a new business is always an exciting and ambitious moment. It gives you a chance to be your own boss, tap into new market opportunities, and build a dream team of your own. Whatever be the reason that drives you to establish your business, there’s a universal rule that must be followed. If you plan to register your business as a Limited Liability Company (LLC), it is essential to follow the rules and regulations from the very beginning. Errors made by business owners during the formation of the LLC manifest in various ways. Such errors can have a long-term impact on the success and smooth functioning of your business. 

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Impact of LLC Formation Mistakes

Establishing a business as an LLC is a long-term proposition. Any error, big or small, can have long-term consequences on the company’s sustainability, profits, and culture. For example, if the company is subject to incorrect taxation codes, it can impact the bottom line of the business and may invite penalties too. Not having all the necessary business licenses in place can have consequences such as fines.  

If the LLC has more than one owner and an operating agreement is not in place, this can lead to conflicts when partners wish to part ways. It can also affect the everyday operations and efficiency of the business. Therefore, the best approach to ensure the longevity of the business is to ensure that the LLC is set up carefully. 

Here’s a rundown of the seven most common LLC formation mistakes and how to avoid them: 

Choosing An Incorrect Entity – A Common Mistake To Avoid While Setting Up The LLC

The LLC is a business structure, which, as the name suggests, protects the owners’ personal assets in the event of a lawsuit. In a way, it is a hybrid structure. It combines the features of a corporation and a partnership or sole proprietorship. Thus the LLC formation is beneficial in several cases.

However, if you aim to build a highly scalable business, seek external capital, and turn it into a large-cap company registered on the stock exchange someday, you might consider registering your business as a C-Corporation. Understanding the scope and vision of the business will help you register it under the right entity.  

Formation Of The LLC In The Wrong State – One of The Serious LLC Formation Mistakes Committed Often

The LLC must be registered in the state where it conducts its business. This is one of the most common errors made by business owners. A lot of people think they should form their LLC in “hyped up” states like Delaware, Nevada, or Wyoming. 

However, if you’re doing business in North Carolina, you’ll need to register your out-of-state LLC as a Foreign LLC in North Carolina. This leads to paying LLC fees, Registered Agent fees, and LLC Annual Report fees in both states. This is in addition to paying fees for a North Carolina LLC Registered Agent. And if you want to start an LLC in New York, the same thing would apply. In summary, it’s best to form your LLC in your home state or the state where you’re conducting business.

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 Not Securing All Business Licenses – Quite A Common LLC Mistake 

Every business has a different set of business licenses relevant to it. For instance, a restaurant and a beauty salon may require a certain set of licenses. Without securing the necessary licenses and permits, your establishment may end up having to pay a fine. 

4: Not Choosing a Unique Name

You’ve got a great business plan worked out. Also, you have the right partners and access to the necessary skills and expertise. But you still need to name your business. When naming your business, it’s a smart idea to choose one that is not very common. This approach comes with three advantages:

  • Customers, collaborators, vendors, and other stakeholders won’t confuse your business with another entity. If they do, it can result in chaos. 
  • A business with a unique name is easier to locate on Google Maps. It also shows up faster on Internet searches. If it is not easy to find in terms of geography or search results, this can result in a loss of business. 
  • The third reason, however, is the most important. Choosing a business with the same name as an existing business might result in a trademark dispute. And it can cause a substantial financial cost. 

Choose a unique, memorable name that communicates your vision of the company.

Not Having a Corporate Governance Framework – A Typical LLC Operating Mistake That Can Become Serious Later

One of the backbones for the success and sustainability of corporations is their corporate governance documents. These build a framework for rules that clearly state what happens in case of disputes and other situations that may arise in the course of running the business. It protects the business, its owners as well as the company assets.

However, when setting up an LLC, many owners make the mistake of not setting up a corporate governance framework. When difficulties arise, these can escalate into major conflicts that jeopardize the business. 

Here are two types of must-have legal documents to protect all stakeholder interests in the business:

  • The operating agreement: This is a legal document. It outlines the ownership of each member expressed in percentages. Also, it explains the profit and loss allocated to each member, the roles and powers of each member, rules related to meetings, holding votes, operating the business, and decision-making.
  • The buy-sell agreement: This is another core legal document that outlines what happens with a member who wants to buy another member out or exit the business under circumstances such as a member’s death.  

It is better to hire a lawyer with experience in setting up an LLC to ensure that the documentation is fair and air-tight. 

Not Being Compliant with LLC Rules 

One of the key benefits of registering as an LLC is that the owners’ personal assets are protected in case of a lawsuit. 

However, these protections only apply if the LLC is compliant with all the rules, regulations, and requirements. For instance, your business will need a unique bank account. Also, you are required to send an annual report every year and need to pay taxes on time. It is important to understand all the guidelines and stringently follow them. If not, you risk losing out on the protections, which can negatively impact your business.

 

 

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Not Investing in Legal Support – One of The Major LLC Formation Mistakes Which Can Prove to Be Costly Later

When starting and running a business, many owners choose to take the DIY approach to handle all aspects of the business. They might also consider not getting any professional legal advice to cut costs. However, this approach can prove costly in the long run. If mistakes are made, such as the corporate governance framework not being well-defined, it can result in financial losses, fraud, and business disruption.  

Having access to legal advice is especially important during times of crisis. Such advice can help in situations when business partners decide to part ways or if you are planning to raise capital from investors. You also need legal support if you plan to open new branches in other states, or if there is a business dispute with vendors or any external agency. At such times, you need a lawyer on speed dial, someone you can trust and who understands your business inside out.

The best approach is to shop for legal support within your networks to find a business attorney with stellar references and experience in setting up an LLC. You need to understand the costs and allocate funds for legal fees within your annual business budget. Legal fees must be viewed as an investment and not a cost. 

The Takeaway 

By avoiding these common LLC formation mistakes, you can lay the foundation for a strong, thriving business. When you don’t need to worry about such matters, it frees up your mental and physical bandwidth to focus on building core aspects of the company. Thus you can focus on strengthening the business product or service and building the supply chain. You can invest more time in building strong marketing, sales, and accounting functions, which collectively help to accelerate the growth of your business.

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