Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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UPDATED: Feb 7, 2020

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A limited liability company (or LLC) is not a corporation, but a hybrid business entity. It combines the advantages of a partnership and a regular corporation. Even though an individual must file paperwork with a state agency to create the LLC, which includes filing membership and operating agreements, the organizational structure is still more similar to a partnership. Rather than shareholders, an LLC has owners. Essentially, the partners become the “owner” of the LLC.

Each state has adopted their own rules regarding the formation and terminology of LLCs.

How to Form an LLC

To form an LLC, a business organization must complete, file, and submit the appropriate filing fee with the application to the appropriate state agency. Membership interest in the LLC is usually set up by percentage. For example, in an LLC with five owners who have invested equally in the business, each would normally have a 20% membership interest. These five owners will share in the profits of the LLC consistent with their percentage of ownership interest. Their interest is not based on stock holdings, but in their membership interest.

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Understanding the Terminology When Forming an LLC

Because rules vary from state to state, so will the terminology regarding the formation of an LLC. Instead of partners, owners are usually called members. They are, however, sometimes referred to as shareholders, because they do own a share of the organization; however, they are not shareholders like the ones of a corporation. Shareholders in a corporation purchase stock to obtain their interest in a corporation. In contrast, an LLC may not issue stock. Any shareholders are actually members with a personal ownership interest in the LLC. Their interest does not stem from the purchase of stock, but from their actual interest in the formation of the LLC.

Benefits of Forming an LLC

Many businesses form LLCs for the limited liability and tax benefits. Compared to shareholders in a major corporation, shareholders or members of an LLC are more prone to the piercing of the corporate veil. This is a principle where the member has engaged in such fraudulent behavior that they can no longer hide behind the LLC protection. The exposure is different because a member is more engaged and involved in the day-to-day operations of the LLC. Shareholders of major corporations are more concerned that their stock stays at a certain level and that they get a good return on their investment.

Getting Help

Before forming an LLC, understand the laws of your state and any overlapping federal statutes. Depending on the structure of an organization, you may eventually want or need to convert to a regular corporation to provide for the sale of stock to shareholders. If this is a potential issue in the future, consult with a corporate attorney before forming the LLC to determine when and where to file LLC paperwork.