The Pros and Cons of LLCs for Franchises
Franchising offers an opportunity to own your own business without some of the risks commonly associated with startups.
This makes them incredibly appealing. Still, franchises aren’t without liabilities. Unless you are properly incorporated, you still carry personal liability for your franchise—despite being affiliated with a larger corporation.
In fact, most franchisors require you to incorporate before signing the franchise agreement. Not only does this limit your liability as a franchisee, but it also increases your credibility as a potential partner. Still, knowing which legal business entity is ideal for your company is a challenge. While C-Corps, S-Corps, and other options are attractive, more franchises incorporate as LLCs every year.
LLCs, or limited liability companies, are not actually corporations. Instead, LLCs are hybrid legal entities. LLCs are similar to corporations in that owners or “members” can limit their personal liability, and similar to partnerships in that income from your franchise doesn’t have to be taxed at the corporate level.
As importantly, LLCs are flexible and easily customizable unincorporated business entities. With the help of the right corporate lawyer, you can customize the operating agreement of your LLC to run simply and easily.
Why LLCs Can Be Ideal for Franchisees
The following are some advantages that may make LLCs a good choice for some franchisees.
- You can choose the most beneficial tax structure for your financial situation. LLCs can be taxed as sole proprietorships, partnerships, or corporations, offering you a lot of flexibility in accounting practices and tax filings. Most people choose LLCs because they can be treated as pass-through entities for tax purposes. Essentially, the company does not pay tax at the corporate level. Net income is taxed only at the individual level, avoiding double taxation and potentially minimizing your tax burden.
- You are subject to fewer bureaucratic requirements. Corporations are legally required to keep strict records and submit regular public filings, while LLCs aren’t. LLCs do not have to hold shareholder meetings or appoint a board of directors. This way, structutung your franchise as an LLC makes it easier to limit the bureaucracy. Just remember, however, that your franchise agreement may still require certain filings, and state law requires you to meet certain standards for accounting practices.
- Your personal assets are protected from business-related claims. LLCs limit your personal liability from claims made against the franchise. You are personally protected from lawsuits and other business claims in most cases.
- The business will remain intact even after your death. Partnerships and sole proprietorships generally dissolve after the death of an owner. LLCs remain intact after the death of a member, making passing it easier to pass on your business without disrupting operations after the death of a partner.
When LLCs Can Be a Disadvantage for Franchisees
Of course, LLCs are not without disadvantages. There are some clear downsides of incorporating as an LLC.
- Your personal liability for the franchise agreement is not limited. Most franchise agreements require you to give way to the corporate shield provided by LLCs and accept personal liability for your obligations to the franchisor. Be aware of this risk, but keep in mind that you cannot avoid this pitfall as a corporation, either.
- You’re legally on your own to figure out how your business should operate. Because few statutory requirements dictate how LLCs must be set up and operate, it can be challenging to structure your company. Luckily, this is mitigated somewhat in most franchises. Your franchise agreement likely gives you some operations guidance and required structure, minimizing this disadvantage of LLCs.
- Getting investment to grow your business can be tricky. LLCs can’t issue shares in the same way that corporations can. This sometimes makes it more difficult to find investors and give them equity in the business. If you have big expansion plans for your franchises, it may be better to consider incorporating as a corporation.
Making the Right Choice for Your Business
Ultimately, it’s up to you to decide which business entity is right for your needs. Talk to an experienced incorporation lawyer to discuss all the pros and cons of LLCs and other incorporation options. They can help you decide if an LLC is right for your business— or if you may want to pursue other options.
Paige Zandri is the Attorney Network Director at Priori Legal, a legal services startup based in New York City. Zandri is in charge of recruiting and vetting the most qualified business attorneys for the exclusive Priori network and is passionate about helping entrepreneurs find quality, affordable legal solutions.