Reader Q&A: Should I Form a LLC or the Business First?

Chicken eggTime for another edition of Reader Q&A! If you have a question for me, feel free to send in your questions. I love hearing from you.

I recently received a question from Kevin C. in Oregon,  who wanted to know: “Would it be better to begin with an LLC when starting your business rather than starting your business and trying to form an LLC later?”

Answer: This is a real “chicken or the egg” question – which should come first?  The LLC? Or the business?

First let me tell you what most stuffy lawyers would say. They’d say you should absolutely form the LLC first. Don’t do a thing until you’ve spent thousands of dollars and weeks of your time devoted to setting up a LLC, including hammering out an operating agreement, filing the articles of organization with the state, etc.

But here’s the thing. A lot of people don’t have the money to do that. Or they don’t know if their business will succeed.  They don’t even know if their business idea is something the market wants.

So why spend all that money and time and hassle when you don’t even know if the business will work?

That attitude is why so many online legal document preparation sites like LegalZoom (affiliate link) have done so well in recent years, and why the legal profession is changing.  But that’s a discussion for another day.

I take a different approach.

You have to understand that everyone has a different amount of resources when starting a business.  There is a full spectrum in terms of where people start out when they start their businesses.

At one end of the spectrum is Donald Trump.  If Donald Trump has an idea for starting a business, he has a team of lawyers, accountants, insurance professionals, and others who hop to work and make sure everything is iron tight before he gets started working on his new business.

Most of us don’t have Donald Trump’s pocket book.

On the other end of the scale are 100% boostrapped businesses. They simply cannot afford to form a LLC because they don’t have the money. They probably don’t have a lot of assets to protect, so the advantages of a LLC are diminished.

If they didn’t take a risk in starting their business without having a separate legal entity set up, then they wouldn’t start the business at all.

That’s not a good thing because we want people to start businesses. It’s good for society. It’s good for creating jobs. Some of our biggest and most successful businesses today were started by founders who didn’t have two nickels to rub together at the outset. That’s what this nation was built on.

There are also people who fall somewhere in the middle. They don’t have Donald Trump’s private jet, but they also are not completely broke.

People start boostrapped businesses all the time without forming a LLC or a Corporation or a Limited Liability Partnership because they want to conserve cash at the outset, because they don’t have many resources to protect, because the complication of setting it up is too much of a barrier, or because they simply can’t afford it. So they just get started as a sole proprietor and deal with the consequences later, or set up an entity later.

If you are starting a business, I think you have to ask yourself where you fall. If you have plenty of resources, sure, hire a lawyer and set up a LLC. Be sure to shop around first and interview a few lawyers.

If you are going to have partners or if you are going to be starting a business where there is greater potential risk of harm to your customers, or if you have assets to protect, then those factors weigh in favor of forming a LLC at the outset.

If you are a little lower on the resources scale, and/or you want to use an online service, then just promise me this: when the business starts making some money, then devote some resources to going back and buttoning everything up.

This is especially important if you have a partner. You’ll want to go back and make sure the operating agreement and/or bylaws of whatever entity you start is not just a cookie-cutter document you got emailed but actually is tailored to your situation.

I love to receive your questions! Send in your questions for Reader Q&A here.

Photo credit: Flickr/Mark Turnauckas

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  • http://lifestoked.com Deacon Bradley

    This is great John. I’ve always felt the same way, but never had those beliefs confirmed from someone qualified.

    I also think of it like this: Compared to getting a business off the ground, forming an LLC is easy. It can be a lot of work, but it’s easy (if that make sense, hah). In a lot of ways it’s “Success Theater.” It feels like you’re making progress, but it’s not doing anything to move the business forward.

    • http://www.smartbusinessrevolution.com/ John Corcoran

      Thanks, Deacon. I wouldn’t exactly say that forming a LLC is not doing anything to move the business forward – it does in fact provide good liability protection. But in terms of viability of the business, I think you’re right, it doesn’t contribute in a substantial way to its eventual success or failure for the most part. You’re better focusing on something really important, like finding paying clients or customers (oh yeah, that… ). : )