First time business owners have a lot to consider when starting a business, but one of the most important early decisions they have to make is deciding what corporate structure best fits the needs of their enterprise. A company’s structure influences a number of aspects of the business including, but not limited to, governance, taxes, and allocation of liability. Choosing an entity type is not a decision that should be made in haste. This decision is so important that it should be carefully thought out and discussed with business partners, an attorney, a tax adviser, and others who will be involved in ensuring the success of the business. For many businesses, one of the structures that should be considered when preparing to form an entity is the limited liability company (“LLC”). The LLC structure combines the taxation treatment of a partnership or sole proprietorship with the limit on personal liability provided to corporations, which results in one of the most flexible structures available to small business owners.
There are numerous advantages to choosing the LLC structure: limitations on the liability of managers and members, flexible management requirements, and pass through taxation. Personal liability of the members is limited to each member’s investment in the business. This limit on liability makes an LLC a much better option than a general partnership or sole proprietorship, as those business structures subject the owners to unlimited liability. Further, LLCs are permitted to pass profits and losses directly through to their owners which can result in the avoidance of the “double taxation” issue faced by some corporate structures.1 The ability to pass business losses on to its members can be very attractive in certain circumstances. As far as management goes, members can manage the LLC themselves or select a manager to run the LLC’s operations. This aspect is among the many reasons why the structure is considered to be extremely flexible.
There are a few potential disadvantages to the LLC structure as well. First, due to their relatively informal nature, at least in comparison to entities like corporations (“C-Corps”), LLCs can be difficult to value properly. LLCs often have custom investment procedures written into each operating agreement and may have different rules for different members’ ownership interests. Therefore, investors are forced to evaluate the benefit of the investment against the sheer amount of effort it takes to value, and invest in, the LLC in the first place. While not always the case, sophisticated investors tend to prefer to invest in C-Corps for this reason alone. Additionally, LLCs are not eligible to offer qualified small business stock (“QSBS”), meaning that investors are not provided the same tax benefits that a qualified small business corporation could provide. Furthermore, all existing membership units of an LLC must be allocated, which means that LLCs do not have the benefit of having treasury stock. This can cause complications if a member decides to sell its equity or if the LLC is working to add new members. Depending on how the LLC’s operating agreement requires the company to handle such events, losing a member or bringing in anyone new could be difficult and confusing for everyone involved. Lastly, foreign investors may find it difficult to have ownership in LLCs because this entity type is fairly unique to the US.
How do I Form an LLC in Colorado?
In Colorado, the Colorado Limited Liability Company Act (the “Act”) governs the organization of LLCs. The Act provides requirements regarding formation, structure, and certain liability protections, so it is advantageous to familiarize yourself with the Act before forming your LLC. After you have decided that an LLC structure is right for you, here are the required procedural steps you must take next:
- Select the name of the LLC you plan to create. Colorado Law requires that an LLC’s name include one of the following suffixes: “Limited Liability Company”; “Ltd. Liability Company”; “Limited Liability Co.”; “Ltd. Liability Co.”; “Limited”; “L.L.C.”; “LLC”; or “Ltd.” For example, if your proposed name for your LLC is “Janedoe Designs,” the legal name of the business would need to include one of the above suffixes, such as “Janedoe Designs, LLC.”Once you have an idea for the name of your business, you must ensure another business is not already utilizing that name. The best way to clear the name is to type in the full name on the Colorado Secretary of State’s database at https://www.sos.state.co.us/biz/BusinessEntityCriteriaExt.do.
- File your new LLC with the Colorado Secretary of State. Click on “File a form to create a NEW record” and then choose “limited liability company.” You will enter the full legal name you have vetted, and then fill out the other considerations on the webform. The webform requires information including:
- Name of the LLC
- The address of the company’s principal place of business
- The name and address of the LLC’s registered agent (must be a Colorado resident)
- This is a representative with an address in Colorado that has consented to receiving legal notices on behalf of the business. This can be you or any member who resides in Colorado. Another option is to hire a registered agent company online or to designate the company’s attorney as the registered agent. This option is best if no members of the LLC reside in Colorado or would like to take on this responsibility at the time of filing.
- The name and address of the person forming the LLC
- Check the appropriate management option (member-managed or manager-managed)
- Manager-managed. Control of the LLC is vested in the manager(s). The manager(s) are not required to be members of the LLC, but they will be in control of the day-to-day operations. In this option, the members take more of a passive role in the organization. This is a good option for out-of-state members, passive investors, and any others who do not want to be bothered by the day-to-day duties of running the company.
- Member-managed. Control of the LLC is vested in one or more of the members. In this case, the day-to-day operations are the responsibilities of the members. Subject to the provisions of the LLC’s operating agreement, all members can actively participate in the management and operations of the business. It is very common for single-member LLCs and smaller organizations, where the owner or owners want a more hand on approach, to be member-managed.
- Check the box stating there is at least one member in the LLC
- Select the Effective Date (you can choose to delay the effective date of the filing if you are still sorting out some of the logistics of the business)
- Sign up for email notifications (this will allow the secretary of state to send you notifications about your business, including when it is time to file a periodic report)
- The true name and address of the person filing the documentYou will then be directed to the transaction confirmation page, and this means the webform document has been filed, the business name is registered, and you have paid the LLC fee through the secretary of state website. Your LLC is now in existence.
- Apply for a Federal EIN Number. The final step you will need to complete takes place on the IRS website, accessed here. Here you will be filing for a Federal Tax I.D. Number (“FEIN”). The FEIN is the tax identification number for the company that is used on tax returns and other financial documents, you can think of this as the LLC version of a social security number. Once you access this website you will choose the “LLC-Limited Liability Company” link on the main page and enter the same name you put on the articles of organization that you filed on the secretary of state website. The webform requires additional information, such as:
- Number of member(s)/partner(s)/owner(s)
- State where you the business is physically located
- Tax classification selection
- DBA name – if you are operating under a different name than the legal name
- Responsible party for the Entity’s information including SSN
- Address of the business
- Entity facts found on the articles of organization
- Other questions regarding the industry in which you operate
- Financial information about employeesOnce the form is submitted, you will be issued a FEIN by the IRS.
The above encompasses the very first, required steps for setting up a LLC, but other considerations for positioning your LLC for success include:
- Opening a bank account under your business name
- Obtain a State Tax Number:
- If you plan to have employees in the State of Colorado you must obtain a Colorado State Wage Withholding Account in order to withhold state income taxes from payroll
- If you plan to sell products in the state, you must obtain a Sales Tax License
- More information can be found on taxcolorado.com
- In Colorado, a business license is not always required. A “general business license” does not exist in the state. However, many businesses do need a specific license or licenses depending on the type of business and how it is regulated.
- The License Database put together by the Office of Economic Development and International Trade lists licensing requirements at both state and local levels
- The Department of Regulatory Agencies maintains a list of licensing applications for the many types of businesses it regulates at the state level.
- Hire an attorney to draft your operating agreement. Creating an operating agreement, which is the document that governs how an LLC operates, adds members, and eventually winds up or is sold, is one of the single most important steps you can take to establish a successful LLC. With the help of a skilled attorney, you will be able to establish polished procedures for the key operational aspects of the business, thus lessening the potential for future disputes regarding administrative matters, before operations even get started.
If you have any other questions concerning how to form or maintain a LLC, please contact The Rodman Law Group, LLC at 720-663-0558.
1. Double taxation occurs when a c-corporation has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend. The c-corporation itself has already paid taxes on that profit, but once it is distributed to its shareholders, they must declare the dividend as income on their personal taxes as well.