The Ultimate Checklist: Top Mistakes to Avoid When Creating An LLC
By Bazal Razzaq
Chief Editor
Updated: June 7, 2023
Editorial Note: We earn a commission if you use the services recommended on this page. Commissions do not affect our opinions or recommendations.
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To err is human, after all! Many entrepreneurs choose an LLC as their business structure, which helps them secure their personal assets from business liabilities. However, some common mistakes new entrepreneurs can make while creating an LLC can lead to legal and financial troubles down the line!
Thankfully, that won’t be the case with you since we’re on your side! We’ve taken it upon ourselves to highlight some common mistakes to avoid when creating an LLC.
This guide explores ten popular mistakes entrepreneurs like you make when creating an LLC, including drafting an operating agreement, registering in the wrong state, totally forgetting to comply, mixing personal and business funds, and more. We’ll dive into each mistake and provide practical tips and solutions on how to avoid them.
Whether it’s your first time creating an LLC or you’re a seasoned entrepreneur, it’s important to understand the potential risks of forming an LLC. Avoiding these mistakes will set your LLC up for success and protect you from unnecessary legal and financial risks. So let’s dive in and learn how to start your LLC on the right foot.
#1: Creating an LLC without an Operating Agreement
When setting up an LLC, it’s important to draft an operating agreement. It lays out the ground rules of your LLC’s functional terms. Also, this document outlines the laws and regulations governing the rights, responsibilities, and rules of your LLC owners/members. However, one common error people make is not drafting an operating agreement or creating an incomplete one.
An operating agreement clarifies the LLC’s operation, including the ownership structure, management and decision-making process, investment contributions, and profit distribution. It also outlines the LLC’s business activities, such as the type of business engaged in, location, insurance, permits, and property ownership.
Not having an operating agreement can lead to many problems, particularly in the event of a lawsuit or litigation. Without an operating agreement, proving how your LLC functions and who is responsible for what becomes challenging, leading to confusion and costly legal battles that could put your company at risk.
But, having an operating agreement saves the LLC members/owners in case of a legal mess. It outlines the LLC’s activities and reduces the risk of personal assets getting seized with the business. Ultimately, an operating agreement can help protect personal finances in a legal dispute.
Working with a legal expert to draft a comprehensive operating agreement that covers all aspects of your business operation is important. But when you could perfectly sit down and do it on your own. Why bother with an expensive attorney? Because it provides clarity and protection for your LLC members/owners and minimizes the risk of legal issues.
#2: Choosing the Wrong State for LLC Formation
The most important decision in forming an LLC is choosing the right state for registration. Unfortunately, many entrepreneurs make the mistake of incorporating in the wrong state, which can cause significant issues in the long run.
While creating an LLC where the business is physically present may seem obvious, it’s worth exploring other states offering more favorable tax structures and benefits. For example, some states provide greater flexibility in LLC formation and offer favorable tax rates that won’t burn a hole in your pockets!
Moreover, some states have specific legal needs that make LLC formation more complex and time-consuming than others. Researching these factors before creating an LLC is critical to a smooth and hassle-free process.
Another thing to consider when selecting a state for LLC formation is if the state is business-friendly. States that are known to support small businesses and entrepreneurs can offer a wealth of worthy resources, such as access to funding and mentorship programs, that can help your LLC thrive.
Yet again, it’s important to conduct thorough research and consult with legal and financial experts before making any solid decisions. Doing so can ensure that your LLC is formed in the right state, giving you the best chance of success.
#3: Failure to Maintain LLC Compliance
Failing to maintain compliance is among the most common errors new business owners make when forming an LLC. Once the LLC is formed, filing the necessary paperwork and beginning operations is not enough. Your LLC should also comply with ongoing requirements to maintain its status.
To be compliant, your LLC should meet certain legal obligations, such as filing annual reports, paying taxes, and maintaining proper documentation. Failure to meet these needs can result in penalties, fines, or even dissolution of the LLC, exposing entrepreneurs like you to potential legal and financial dangers.
It’s essential for business owners to be aware of the requirements for maintaining LLC compliance and to follow them properly. LLC compliance includes understanding the filing deadlines and requirements specific to their state and ensuring all required paperwork is completed accurately and on time.
Another important aspect of LLC compliance is keeping up with state and federal laws that may impact your LLC’s status. You should stay informed about regulatory changes and consult with legal and financial professionals to make sure they comply with the laws and regulations.
It’s important to stay informed about the ongoing needs to maintain LLC status and to follow them to avoid penalties and legal liabilities. By doing so, entrepreneurs can protect their businesses and ensure long-term success.
#4: Mixing Personal and Business Finances
Another error made when forming an LLC is mixing personal and business finances. While using personal funds to support your LLC may be tempting, it can cause serious issues and jeopardize your LLC’s legal status.
For this very mistake, it’s important to maintain separate accounts for your private and business activities. You should use your LLC’s bank account exclusively for business purposes, such as paying bills, purchasing inventory, and collecting revenue. Similarly, use your private accounts only for personal expenses like mortgage payments, car loans, and groceries.
It’s important to keep detailed and organized records of all financial transactions, including receipts and invoices, to demonstrate that your personal and business finances are separate. Failure to do so can cause potential legal issues down the line, especially in the event of a tax audit or lawsuit.
Finally, avoiding using your LLC funds for personal expenses, such as vacations or entertainment, is ignorant at best. Doing so can put your LLC’s legal status at risk and make it difficult to keep track of your business finances and report them to the IRS.
Maintain separate accounts, keep accurate and organized records, and avoid using business funds for personal expenses. Doing so can protect your LLC’s legal status and ensure its long-term success.
#5: Relying on Online Legal Forms
Many new entrepreneurs make the mistake of relying solely on online legal forms when forming their LLCs. While it may seem like a cost-effective and time-saving solution, it can lead to potential legal dangers in the future.
Online legal forms aren’t tailor-made to fit every business’s specific needs. They often fail to consider a particular LLC’s unique and specific situations, resulting in incomplete or incorrect information. Also, these forms don’t offer business owners legal advice or guidance.
Not seeking legal guidance can lead to unnecessary problems such as improper filing, missed opportunities for protection, and even litigation. It’s important to consult a qualified attorney who can provide tailored legal advice and help you understand the complex legal needs of forming an LLC.
While it may be more expensive, investing in professional legal help can ultimately save money and prevent potential legal difficulties.
#6: Neglecting Timely Bookkeeping
Another mistake entrepreneurs make is failing to keep up with timely bookkeeping for their LLCs. Proper bookkeeping is important for businesses, especially for LLCs. Business owners should maintain a proper transparent record of all revenue and expenses so they won’t get overwhelmed at the time of tax audit. If you don’t keep timely bookkeeping, you might forget to account for a revenue or expense item, leading to inaccurate tax returns.
Having accurate bookkeeping records also helps business owners to justify a transaction during a tax audit. With clear bookkeeping records, you can back up your transactions with evidence, making the auditing process simple and less stressful.
One way to ensure timely bookkeeping for your LLC is by using online accounting software, such as Quickbooks. These tools come in handy when keeping track of your monthly revenue and expenses, making it convenient for you to manage your money and stay on top of your bookkeeping requirements.
The Bottom Line
In conclusion, creating an LLC can be challenging, so avoiding blunders that could hurt your LLC is important. You may safeguard your company, personal assets, and future success by being aware of these mistakes and adopting the appropriate measures.
Take the time to thoroughly design and form your LLC, and whenever required, seek professional help. To ensure that your LLC has a solid and secure foundation for your business to grow and prosper, avoiding these frequent blunders is important. Always remember that creating an LLC is just the start of a long and satisfying journey.
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Frequently Asked Questions
When choosing an LLC name, it’s important to avoid picking a name already used by another business. Also, make sure that your chosen name complies with your state’s LLC naming rules, which often require using specific words like “Limited Liability Company” or “LLC.”
One common mistake new entrepreneurs make is filing incomplete or inaccurate documentation. Ensure you complete all the required forms correctly and provide all the required information.
Another error is not taking filing deadlines set by your state seriously. Missing deadlines may result in fines, penalties, or the rejection of your LLC formation status.
A common mistake is not clearly describing the ownership structure and member contributions. It’s important to set the percentage of ownership for each member/owner and document their financial contributions to avoid fights or misunderstandings in the future.