Is an LLC Best for My Franchise Business?

Today’s biggest franchises include McDonald’s, Subway, 7-Eleven, Hertz, and Marriott. In fact, there are more than 750,000 franchises in the United States, providing jobs to more than 8 million people.

While the restaurant industry is made up of numerous international franchises, franchises exist in every type of industry. For example, convenience stores, such as 7-Eleven and Circle K; educational franchises, such as Kumon Math & Reading Centers; eye care centers, such as Pearle Vision; spas, such as Massage Envy; real estate professionals, such as RE/MAX; and specialty retailers, such as Ace Hardware.

So why are franchises so popular?

Franchises—defined as one business (the franchisee) that pays another (the franchisor) to use the franchisor’s business model and trademarks—are extremely appealing because owning a franchise allows you to work for yourself—but not by yourself.

Franchising enables you to open your own business with the guidance and support of a larger parent company. Not only are you the boss, but the franchisor provides a ready-made outline for your new business to follow. And using this outline can greatly simplify and reduce the pain sometimes associated with starting and growing your business.

If you are looking to become an entrepreneur, but don’t want the risk associated with building a business, buying a franchise can be a great option. The risk is low and the revenue possibility is high. Along with high-profit margins, you are provided with the support and resources of a larger company.

However, franchises still come with some liabilities. It is important to understand that while you are affiliated with a larger, well-established organization, you still carry personal liability for your franchise.

And that’s where legal structures come into play. Choosing the best legal structure is a big decision for new franchisees because the legal structure of a franchise can greatly impact legal obligations, tax implications, operations, and profits. Simply put, determining the proper legal entity should be decided before signing a franchise agreement.

The most common legal structures include S-corporations, C-corporations, sole proprietorships, and limited liability companies (LLCs). Let’s take a closer look at LLCs and how they function within franchises:

What are LLCs? An LLC is a limited liability company. LLCs limit the liability of the owners/shareholders from the debts of the business and against lawsuits against the business.

Why create an LLC? The main reason to form an LLC is to limit personal liability because LLCs have their own existence. Think of them as artificial persons. The LLC owns the business, not the people forming it. LLCs enter into their own contracts and deals, can sue and be sued, and are liable for their own debts and obligations.

What are the benefits of creating an LLC for your franchise? There are several advantages that make LLCs a good choice for franchises. These include the following:

• Incorporating your franchise business creates a legal barrier between your business liabilities and your personal assets.
• Many customers, business partners, and investors consider a business to be more credible if it is incorporated.
• It is common for franchisors to prefer to work with an LLC.
• LLCs can be governed informally. They do not require a board of directors, meetings, quorums, minute keeping, and other management formalities.
• LLCs have flexibility in deciding how to split their financial interests. An LLC can distribute its income to each member equally, based on his or her capital contributions, or in many other ways.
• An LLC can be a pass-through tax entity without the restrictions that are imposed on corporations.
• Because LLCs remain intact after the death of a member, it is easier to pass on a business without disrupting operations due to the death of a partner.

What are the downsides of creating an LLC for your franchise? LLCs also have disadvantages for franchises, which include:

• Your personal liability for the franchise agreement is not limited. However, be aware that cannot avoid this problem as an LLC or as a corporation.
• There are few statutory requirements that mandate how LLCs must operate, so it can be challenging to structure your company.
• Because LLCs are unable to issue shares in the same way that corporations can, it can sometimes be tricky to find investors and offer them equity in the business.

Who owns the LLC?

Individuals called “members” own an LLC. These owners have an equity interest in the assets of the business, shown in the business balance sheet as owners’ equity.

How are the profits and losses of an LLC managed?

LLC profits and losses are passed through to individuals.

How are LLCs taxed?

LLCs are taxed based on adjusted gross income of the owners.

Franchise owners must decide which business entity is right for their specific needs. It can be helpful to talk to an experienced incorporation lawyer to discuss the many pros and cons of LLCs and other incorporation options. These professionals can help you decide if an LLC is right for your business.