When to establish a Limited Liability Company for your business? Advantages and disadvantages

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When to establish a Limited Liability Company for your business? Advantages and disadvantages

When to establish a Limited Liability Company for your business? Advantages and disadvantages

At some point, various daily work situations lead freelancers to question whether it would be advisable to establish themselves as a Limited Liability Company (LLC). The answer to this question differs greatly according to the situation of each business, but understanding this type of company better, as well as its advantages and disadvantages, can assist in the decision-making process.

What is a Limited Liability Company?

Let’s start by distinguishing that a Limited Liability Company, also called an LLC, is a legal entity. This allows it to separate its assets, risks, and responsibilities from those of the physical persons who are its partners. This contrasts with the freelancer, who is a physical person and whose assets are the same as those of the company. Therefore, they assume the risks and responsibilities of daily work.

The LLC must have its own name or corporate name, address, corporate purpose, bylaws, and organization. Also, the general meeting of partners must appoint an administrative body – which can be a single administrator or several joint or several administrators, or a board of directors.

Partners can contribute to the company’s assets the amount of money or goods they consider convenient. To incorporate the Company, a minimum capital is no longer required, but partners will be liable for up to 3,000 euros and having a capital of less than 3,000 euros generates more hurdles that make this option inadvisable.

In terms of tax obligations, the LLC must pay taxes such as corporate tax and VAT. While the social security responsibilities require registering the company’s workers under the general regime, except for administrators and partners who are considered self-employed.

In contrast, freelancers must pay the Personal Income Tax and as such are registered in social security – this means that, depending on the tax bracket, a freelancer may establish an LLC for tax efficiency reasons if their income tax bracket is high.

These are, in summary, some of the main characteristics of an LLC, but to deeply understand this type of company and whether it is advisable to establish it, let’s look at its advantages and disadvantages:

Advantages of the Limited Liability Company

  • The first and clearest advantage of an LLC is that in case of debts or bankruptcy, it is the company’s assets, not the physical persons of the partners, which are affected.
  • Allows both a single partner and the association with an undetermined number of physical persons within an already established legal framework. These can be worker partners or capitalist partners. Also, unlike a public limited company, it can control who forms it given the rights of acquisition and preferential subscription of shares.
  • Tax payments can be lower than for a freelancer, because while the freelancer pays between 19% and 48% of their profits, the LLC only pays between 15% and 25%.
  • Possibility of deducting some expenses more easily than for the self-employed person.
  • It is incorporated much more easily and economically than a Public Limited Company, it can be done virtually and at a cost of around 600 euros. Its legal regime is also simpler than that of PLCs.
  • Better growth opportunities than a freelancer. This, eventually, facilitates attending public and private tenders, something quite restricted for physical persons, due to the demands of team size and substitute profiles of the employees presented in the proposals.

Disadvantages of the Limited Liability Company

  • Requires a specific organizational structure independent of its partners, with the establishment and ongoing management costs this generates.
  • A more complex accounting system than that of the freelancer is required – especially as the company grows.
  • The transfer of shares is restricted, requiring the approval of the general meeting of partners, except that there is a family link between the acquiring partner and the transmitting one, or that something else is established in the Bylaws. In any case, a public deed is required to transfer shares, increasing their cost and reducing their transmission speed.
  • It cannot go public.

When to Establish a Limited Liability Company

As initially mentioned, the decision to establish as an LLC depends on the characteristics and environment in which the business finds itself. There are four basic factors to consider: risk, annual turnover, business opportunities, and whether you work with other people.

Risk is important to consider because the higher this is, the more likely the freelancer’s assets may be affected. For example, a high risk of sanction or debt may lead to defaults that generate enforcement processes against the freelancer’s assets, potentially leaving them homeless and subject to a personal bankruptcy process.

Similarly, the higher the annual turnover of the business, the higher the tax obligations will be. For this reason, from approximately 40,000 euros of profit, perhaps the most advisable would be to generate an LLC, as – as we have seen – corporate tax is lower than income tax. This is particularly true if the aim is to reinvest the earnings, since if we distribute the profits, the corporate tax will have to be added to the income tax on capital returns, which makes it not so efficient.

Another very relevant factor for many freelancers are business opportunities, because many large companies only contract with companies that have greater legal backing, and a Limited Liability Company is more able to generate an image of solvency than a physical person freelancer.

Finally, it is advisable to consider establishing a Limited Liability Company when there are many dependent workers or you want to formally associate with another freelancer. This will allow delineating responsibilities with employees and partners, in this last case, establishing what will also be the benefits of each one.

Procedure to Incorporate a Limited Liability Company

In summary, to establish a Limited Liability Company, 7 basic steps must be taken:

  1. Register the corporate name of the company. To do this, it will be necessary to go to the Central Commercial Registry to request the negative certification of the company name. This document indicates whether there is another company with the same name or not and is valid for three months. If negative, it automatically generates the name registration for 6 months.
  2. Create a bank account in the name of the company. With the negative certification of corporate name, a bank account should be opened in the name of the company, in which the initial capital will be deposited.
  3. Draft the bylaws. With the help of a lawyer, the bylaws should be drafted containing the basic information of the company such as its name, legal form, domicile, capital stock, shares, among others. You can also go to a Point of Attention to the Entrepreneur, where you will find a standardized format of this document – which has certain deficiencies, but is practical because it allows for more agile constitution.
  4. Sign the public deed of incorporation of the Limited Liability Company. Before a notary, all previously managed documents must be taken, plus the ID of the partners, the NIE of the administrators who are foreigners and, if applicable, the declaration of investments of foreign partners.
  5. Carry out tax procedures. It will be necessary to go to a Tax Agency to request a provisional Tax Identification Number (NIF). Also register in the Economic Activities Tax (IAE) and make a census declaration of the start of activity (model 036).
  6. Register the constitution of the Limited Liability Company in the Commercial Registry. With all the previous documents plus the model (exempt) of the Tax on Patrimonial Transmissions and Documented Legal Acts, if required.
  7. Obtain the definitive NIF. To do this, you must go to the Tax Agency or online, carrying the provisional NIF, the ID of the representative of the company, and a copy of the public deeds.

In conclusion, the decision to form a Limited Liability Company (LLC) should be a carefully considered one, taking into account factors such as risk, annual turnover, business opportunities, and the presence of dependent workers or other partners. While there are many advantages, including potential tax benefits and liability protections, there are also disadvantages such as more complex accounting and restrictions on share transfers. 

Ultimately, the choice to form an LLC will depend on the unique circumstances and needs of each business.

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