Starting a new business is never without its risks. One of the best ways to mitigate that risk is to start a franchise. While the success of a franchise is never guaranteed, owner-operators do have some built-in advantages, including name recognition.
Another way to limit the risk of your new business venture is to choose the right legal structure. Even with a franchise, owner-operators open themselves up to certain liabilities. Structuring their business properly can curb these liabilities.
So which business structure is best? One option is to open an LLC in California, or whichever state you’re active in. Not only is this a viable option for franchisees, but it can also be a highly advantageous one. And, it offers the opportunity to choose from a number of potential tax classifications, including S-Corp.
What are LLCs?
If you’ve never heard of an LLC or limited liability company, it may be helpful to start with a quick definition.
While LLCs are often considered to be corporations, it may be more useful to think of them as hybrid legal entities. On the one hand, they limit the owner’s personal liability. In other words, the LLC structure helps you keep your business assets separate from your personal assets, which can be crucial if you are ever threatened with a lawsuit.
On the other hand, the LLC structure does not require your business to be taxed at the corporate level. Additionally, there is plenty of flexibility to customize the operating agreement of your LLC, which means you have wiggle room to run the company how you see fit.
Why are LLCs Well-Suited for Franchises?
While the LLC structure may not make sense for every franchise owner-operator, there are a number of advantages that it offers.
LLCs Can Offer Tax Benefits
Business owners never exactly look forward to tax season but owning an LLC can take some of the stings out. That’s because incorporating your franchise as an LLC actually allows you some choice about the tax structure you choose.
An LLC can technically be taxed as a partnership or a corporation, but most LLC owners will want their business to be treated as a pass-through entity. This means net income is taxed at the individual level, which enables the LLC to avoid double taxation.
LLCs Mean Fewer Bureaucratic Requirements
If you structure your franchise as a corporation, you will have to deal with many regulatory compliance issues. For example, you will be required by law to submit regular public filings and to maintain rigorous financial records. While an LLC may be required to make certain kinds of filings, the bureaucratic burden is significantly less overall.
LLCs Allow You to Shield Your Personal Assets
One of the main reasons for franchise owner-operators to consider the LLC structure is that it provides a way to shield personal assets from business-related claims. What this means is that if somebody brings a lawsuit or legal claim against your business, it will not jeopardize your family’s bank account, your personal property, etc.
Are There Disadvantages to the LLC Structure?
These advantages are notable, but franchise owner-operators should also be aware of a few potential drawbacks. Here are some of the reasons why the LLC structure may not be right for every franchise.
You Still Have Liability in the Franchise Agreement
While the LLC structure limits your personal liability, a franchise agreement may counteract this. Many franchise agreements will force you to accept some level of personal liability to the franchisor, which weakens the corporate shield that an LLC creates. This is a notable drawback for franchisees to be aware of, but note that the same drawback holds true if you structure your business as a corporation.
Getting Investments May Be Difficult
One of the most common concerns about the LLC structure is that it does not have the option to provide investors with shares of the company. As such, many would-be investors may be reluctant to back an LLC.
However, if you have any kind of built-in resources or financing structure from your franchisor, this may not be an issue at all.
You May Have to Figure Out On Your Own How to Operate the Business
There are surprisingly few regulations to govern how an LLC is set up and how it is run. Some owner-operators may find this liberating, while others will find it intimidating.
Knowing how to set up your company can be difficult. Here again, though, being a franchisee can actually be an asset, as most franchise agreements will furnish a lot of instruction about how to set up the business.
For Franchise Owner-Operators, LLCs Can be the Best Option
Though the LLC structure may not be the best option universally, there are a number of ways in which it actually works harmoniously with the particulars of franchising. To summarize some of these key points:
- • Starting a franchise often eliminates some of the financial uncertainties that affect other startups, particularly questions about fundraising. This also mitigates one of the major drawbacks with LLCs (namely that it can be hard to attract investors).
- • While launching an LLC can sometimes be too open-ended for those who have minimal business experience, the operating agreements that come with franchises can create a greater sense of clarity and direction.
- • Franchise owners often want some say in the kind of tax structure they operate under. An LLC can provide that.
The bottom line? Launching any new business brings certain risks and liabilities, but these risks and liabilities can typically be mitigated. One way to minimize risks is to choose a franchise business model. And another is to incorporate as an LLC.
By combining these two measures, you may be able to position your business for long-term success.
Amanda E. Clark
Amanda E. Clark is a contributing writer to LLC University. She is a graduate of Eastern Michigan University and holds degrees in Journalism, Political Science, and English. She became a professional writer in 2008 and has led marketing and advertising initiatives for several Fortune 500 companies. She has appeared as a subject matter expert on panels about content and social media marketing. She regularly leads seminars and training sessions on trends and tactics in professional writing.