While a single-member LLC is the simplest and most flexible type of LLC you could form, it does have certain risks, just as any business venture does. These risks range from the difficulty of raising capital to the fact that single-member LLC owners are personally liable for all the obligations and debts of their business. It is incredibly important that you be aware of these risks, so you can plan accordingly and know how to mitigate them. It is equally important to know which alternative business model you can use as you work to launch your company.
WHAT RISKS, SPECIFICALLY?
One of the biggest drawbacks of single-member LLCs is that their owner bears full responsibility for things that may go wrong. A single-member LLC does not involve any other members by its very definition. The owner is the sole individual making decisions. That means that the onus of a wrong decision is on them and them alone. This can prove problematic under several circumstances. If, for instance, an LLC owner has incurred business debts and if they haven’t kept their business and personal assets separate, this could put their personal assets at risk. The limited liability protection that LLCs afford their owners might not really do much in this case. Neither would it do much of anything if the case were to go to court and the court were to decide that the owner of a single-member LLC was personally liable for those debts.
At present, only three states in the US afford single-member LLCs the same kind of protection that is afforded to traditional, multi-member LLCs. On top of that, some states go as far as to deny protection to the owners of SMLCCs. That being the case, it is important that you look up the limited liability laws of your state as they pertain to single-member LLCs if you are considering starting your own.
Another disadvantage that comes with single-member LLCs is that their owners are subject to self-employment taxes. While the reasons for this make sense, it does not change how great an expense self-employment taxes can sometimes amount to. This—compounded with how hard it may be for LLCs to raise capital given certain investors’ reluctance to do so—can put a certain degree of financial strain on an LLC owner.
ALTERNATIVES TO THE LLC ROUTE
The most appealing features of LLCs are their flexibility and simplicity, as we have said. But they can come with some unique quirks. As such, thinking about starting a different kind of company than an LLC is very understandable. Luckily, there are alternative corporation models you could consider adopting that have similar advantages to LLCs without the disadvantages.
The first of these possible models are sole proprietorships and partnerships. A sole proprietorship can be defined as a business that is owned by a single individual (Chaves, n.d.). A boutique or a corner bookshop, for instance, might be examples of sole proprietorships. So might a construction contractor. The defining feature of sole proprietorships is that they allow their owners to reap all the financial profits that their business offers up. They also get to pay lower taxes as their income is considered to be their personal earnings. On the flip side of that coin, though, sole proprietors have the full burden of responsibility should their business fail. That means that, unlike what happens with LLCs, debt collectors would be able to hold them personally liable without any kind of limit should their business fail.
If a sole proprietorship can be considered an alternative to a single-member LLC, a general partnership can be considered to be for a multi-member LLC-member LLC. A general partnership usually has at least two partners who share equal liability for their business. That means that those partners divide their profits, costs, losses, and expenses equally. The same applies to the work they have to do for their partnership. Of course, the more partners a general partnership has, the wider and deeper its pool of investors and expertise will naturally become.
Then there are C corporations. C corporations are subject to double taxation. That means both the income of C corporations and the income of the individuals who are shareholders of those corporations are taxed. This is something that makes C corporations unappealing to some, but this model is not without its advantages. For instance, C corporations are required to pay dividends on company earnings. Similarly, losses that C corporations suffer do not get passed onto their owners and shareholders. However, it should be noted that this also means C corporation owners are not allowed to claim any tax benefits for their losses, if and when they occur.
If you are looking for an alternative to LLCs with distinct tax benefits, then S corporations might be the way to go. S corporations have, at most, 100 owners, all of whom are subject to limited liability. These owners are taxed on their personal income levels, the way general partnerships are.
Some S corporations are subject to corporate tax, which is a tax that is imposed on the capital or income of corporations. Whether or not an S corporation is subject to such a tax depends on what state it is in (Kagan, 2021). S corporations are not the only entities that allow for certain tax benefits. Limited partnerships, for instance, can help their owners avoid self-employment taxes (Chaves, n.d.). A limited partnership is a business that has co-owners. All or some of these co-owners might be limited partners, meaning that they can enjoy limited liability protection. If that is the case for a co-owner, then that means that their liability is limited to the amount that they originally invested. Logically, the more people invest in a limited partnership, the more profits get divided. So, the owners of a limited liability company would end up investing more and obtaining smaller profits than they might have liked.
WHY SHOULD YOU CHOOSE A MULTI-MEMBER LLC OVER A SINGLE-MEMBER ONE?
The most obvious—and therefore likely most easily overlooked—alternative to a single-member LLC is a multi-member one. After all, multi-member LLCs offer their owners the exact same benefits as single-member LLCs. Both are equally flexible and simple when it comes to managing and forming them. The key difference between them, which might make multi-member LLCs the more appealing option out of the two, is this: if you start a single-member LLC, you will be the sole person liable for your business and any debts it might incur. However, if you start a multi-member LLC, then that liability will be shared equally between you and your partners.
Of course, the same thing goes for any profits that your multi-member LLC turns in. Those profits will be divided equally among all co-owners. So, if you want a format where you get to keep all of the profits, then this might make a multi-member LLC-member LLC suboptimal for you. Then again, you might reconsider just how suboptimal this option is once you discover that multi-member LLC owners do not have to pay self-employment taxes, which can be hefty, as mentioned before. This, combined with the fact that multi-member LLCs are eligible for certain kinds of tax deductions and credits that single-member LLCs simply are not eligible for, might make you warm up to the idea of them (UpCounsel, n.d.-b).
What you have to do if you are trying to decide between single-member LLCs and multi-member LLCs (and any other business entities, really) is to consider what you want and need. Do you want the simplest possible business model? If so, then you should choose a single-member LLC over a multi-member LLC, because the latter is a bit more complicated to run, given that there are more people involved
involved in it. Do you want to avoid self-employment taxes and share your liability with others? If that is the case, then you might want to go with a multi-member LLC.