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If you’re considering becoming a franchise owner, you might be wondering whether forming a limited liability company (LLC) is the right choice for your business venture. In this guide, we’ll explore the key considerations and benefits of forming an LLC for a franchise.
Forming an LLC for your franchise can offer several advantages that provide protection and flexibility to your business operations. One of the primary benefits of starting an LLC is the limited liability protection it provides. An LLC also enhances professionalism and credibility in the eyes of your customers, franchisors, and even potential business partners. Last but not least, LLCs enjoy tax benefits like avoiding double taxation because they’re considered pass-through entities. They can also choose the tax status that works best for them.
In this guide, we’ll provide you with step-by-step instructions and valuable insights on how to form an LLC for your franchise. Whether you’re a first-time franchise owner or an experienced entrepreneur expanding your business portfolio, forming an LLC can be a crucial step toward building a successful and sustainable franchise business.
Yes, an LLC can indeed be a franchise. While franchises are typically associated with specific business models and branding, the legal structure of the franchisee entity can vary. Many franchisees choose to operate under the legal structure of an LLC due to its flexibility, limited liability protection, and tax advantages.
Starting an LLC allows franchisees to separate their personal assets from the liabilities of the franchise business, providing an additional layer of protection in case of legal issues or financial challenges. This can be particularly beneficial in industries where there may be higher risks or liabilities involved. Additionally, operating as an LLC offers flexibility in how the business is taxed, allowing franchisees to choose the most advantageous tax treatment for their specific circumstances. Overall, choosing to structure a franchise as an LLC can provide franchisees with both legal protection and financial benefits, contributing to the long-term success and sustainability of the franchise business.
The top reason to form an LLC for a franchise business is to gain access to the personal liability protection provided by this business structure. Whether you operate a restaurant in a popular fast-food chain or a retail convenience store with a wide variety of products, you need the limited personal liability protections that an LLC can provide.
With a franchise, it’s important to form an LLC before you ever sign your franchise agreement. This is because it’s vital to have personal asset protection before you start transacting business. If you don’t, a creditor could claim that they did business with your company when it was a sole proprietorship or general partnership, and the courts would likely grant them access to your personal assets.
As an example of how an LLC can limit personal liability, let’s say that a customer slips on a wet spot on your floor, falls over, and injures themselves. If you operate your franchise as a sole proprietorship or general partnership, your personal assets — like your house, car, or personal bank accounts — would be at risk if that customer decides to sue your business. In short, you’d carry personal liability for the business.
On the other hand, if you form an LLC for your franchise before you begin conducting business, and you operate and maintain that LLC in a compliant fashion, the scope of your customer’s lawsuit will be limited to your business assets. In other words, your assets will be protected by the business structure you’ve chosen.
This is just the tip of the iceberg when it comes to the advantages of the LLC for a franchisee. Another important aspect is taxation. The LLC actually provides its owners with a selection of options regarding how they want the business to be taxed, which can save you a considerable amount of money compared to simply operating as an informal business entity.
Your franchise LLC can be taxed as a sole proprietorship (for single-member LLCs) or general partnership (for multi-member LLCs), which is the default option. When taxed like sole proprietorships or general partnerships, LLCs don’t pay taxes themselves. Instead, the profits are passed through the business entity and your owners pay taxes on that money when they file their own personal taxes.
You can also choose for your franchise to be taxed as a What is a C corporation?, although this option isn’t very popular because it subjects your business to what’s known as double taxation — meaning that your profits are taxed first on the corporate level and again on the personal level when they’re distributed to your owners.
The other option is S corporation (please see our What is an S Corp? page) taxation. There are quite a few limitations to electing S corp taxation, but most franchise businesses have no trouble meeting these requirements — your business can’t have more than 100 owners, they all must be either residents or citizens of the United States, and so on.
S corp taxation can help your franchise save money by reducing your self-employment tax burden. Instead of paying self-employment taxes (a 15.3% tax that includes the employer and employee portions of Medicare and Social Security) on all of your business income, you can pay yourself and your co-owners a reasonable salary for your roles and only pay self-employment tax on that portion of your income, while you can reinvest the rest of it into your business without paying this tax.
Compared to operating a sole proprietorship or general partnership franchise business, the S corp taxation model can save you quite a bit of cash that you can use to make improvements to your business, rather than writing a big check to Uncle Sam.
Finally, an LLC structure can enhance the credibility of your franchise business venture. Informal business entities don’t have exclusive assumed business names and typically operate under the personal name(s) of their owner(s). For instance, if your name is Johnny Smith and you operate a franchise sole proprietorship, your company’s name is also “Johnny Smith.”
Of course, this issue is much less important with franchises, because the public perception of a franchise is typically more in line with the parent company than the individual franchisee. Still, it’s undeniable that your vendors and business clients will take you more seriously if you form a formal business structure.
With an LLC, you not only have the rights to exclusive use of a business name, but you will also have either the phrase “limited liability company” or the letters “LLC” in that business name. This provides your business with a jolt of respectability because vendors, partners, and clients respect the professionalism displayed by an LLC. Also, they typically feel more comfortable writing checks to a business entity rather than to an individual.
LLCs are formal legal entities that are typically taxed similarly to sole proprietorships and general partnerships, in that the owners include any company profits or losses into their personal returns — the LLC itself does not owe income taxes. An LLC may also elect to have a corporation’s tax structure, although this is not a very common option.There are similarities to corporations, too, especially when it comes to financial responsibilities. In an LLC, the owners (known as members) are not usually personally accountable for the financial status of the business. This means that if someone sues your LLC, your personal assets are usually not at risk. For more information see our LLC definition page.
The formation process for LLCs varies depending on which state you’re forming one in, but in general, the process has some universal steps that need to be taken no matter what state your business is located in. If you want a comprehensive overview of all the steps required to form an LLC, check out our complete guide on the topic. The basic steps in the LLC formation process in any state are as follows:
Coming up with the perfect name for your new LLC is an important step. You’ll need to choose a name that represents your company and describes what you do, and you’ll also have to make sure it isn’t already in use by checking your state’s business database.
Your LLC’s registered agent (For more information, please see our what is a registered agent page) (which can be an individual or a professional service) is responsible for receiving important document deliveries from the state — like service of process or annual report reminders — and forwarding them to you. The registered agent ensures that the state always has a reliable point of contact for your business.
The form used to create an LLC is usually called the Articles of Organization, although the name can vary (some states call it the Certificate of Formation or something similar). You’ll need to provide the state with some basic information about your business and its owners. In exchange, the state will formally create your LLC.
The Employer Identification Number (EIN) is a federal tax ID number that essentially functions as a Social Security number for a business. The What is an EIN allows your business to hire employees, pay taxes, apply for bank loans, and more. You can obtain an EIN from the Internal Revenue Service free of charge.
New in 2024, your franchise LLC is required to file a beneficial ownership information report, or BOI report. You’ll file this report with the Financial Crimes Enforcement Network, providing vital information about your LLC’s “beneficial owners.” Beneficial owners are people who control the LLC or get significant economic benefit from it. It’s crucial to file this report by the deadline to maintain compliance; failing to file means you won’t be operating your franchise LLC legally and you could face hefty legal and civil penalties.
Most states don’t require operating agreements, but every LLC should have one regardless. This is an internal document that outlines several key operational aspects of your LLC. The value of the operating agreement is how it can help prevent ownership disputes down the line by clearly explaining how the LLC will be run.
You will need a business bank account for your LLC, and you’ll probably want a business credit card for work-related expenses, as well. It’s also a good idea to use accounting software like QuickBooks or even hire an accountant to handle your bookkeeping for you.
Depending on your state, you may need a general business license to operate your LLC in compliance with state requirements. In most states, you will need to register your franchise with the state before conducting business. Don’t forget to check with your state to see if there are franchise or privilege taxes assessed on LLCs, and also see if your municipal and/or county government entities have any further licensing requirements.
Again, these requirements can vary by state, but most states require some sort of regular report to ensure that your LLC’s info is up to date in the state’s business database. Some states require annual reports (each year), while others only require them biennially or not at all. No matter what your state requires, you’ll need to stay on top of it to keep your LLC in good standing.
Score.org provides franchise business owners with a wealth of information, from webinars to guides, blogs, virtual classes, and more. If you’re looking for advice on franchise agreements, financial considerations, or any other aspect of franchise ownership, you’ll likely find it with Score.org.
Free Management Library offers resources for entrepreneurs in a wide variety of business types, and they have a great library of tools for franchising, as well. They have plenty of information about preparing to become a franchise owner, how to choose the right franchise, funding your franchise, and more.
The mission of the American Association of Franchisees & Dealers (AAFD) is to “educate the public regarding fair franchise practices, quality franchise opportunities, and to expose the unethical practices that have too long existed in the franchising community.” The AAFD’s website has information on fairness initiatives, buying a franchise, and much more.
Franchising.com markets itself as “your complete guide to buying a franchise opportunity,” and we’re not about to argue! Their site has a ton of info for franchise LLC owners, with sections on news and opportunities, and information about conferences and webinars.
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Starting an LLC for a franchise might seem like a daunting task, but it isn’t one you have to navigate alone. Here at ZenBusiness, we specialize in handling the red tape side of business. Whether you need help starting your LLC, managing your finances seamlessly with a Money app, or anything in between, we’ve got you covered. Let us tackle the paperwork so you can focus on what you love: managing your franchise business.
What liability risks do franchise owners face?
In many cases, franchises have even greater liability risks than standalone businesses. For instance, let’s say you operate a restaurant franchise. As a restaurant, this business is subject to lawsuits due to slip-and-fall accidents, food poisoning issues, and more.
However, the franchise restaurant must also abide by the guidelines set forth by its parent company—if you don’t, you could lose your franchise or even be sued by your own parent company! As you can see, it’s vital for every franchisee to form an LLC or corporation to protect their personal assets from business-related claims.
How does a franchise agreement compare to an operating agreement?
A franchise agreement and an operating agreement serve different purposes in the context of business operations. While most franchise agreements outline the rights and obligations of both the franchisor and the franchisee, focusing on the use of the franchisor’s brand and business model, an operating agreement typically governs the internal workings and management structure of an LLC. While a franchise agreement is specific to the relationship between the franchisor and franchisee, an operating agreement is tailored to the needs and requirements of the LLC’s members and managers, detailing matters such as ownership interests, decision-making processes, and profit-sharing arrangements.
Why should I form an LLC instead of a corporation?
Everyone’s situation is different, and we’re not here to provide legal advice. That said, the LLC has some concrete advantages over the corporation that makes it the preferred option for most small businesses, all while maintaining a corporate shield to protect its owners.
Corporations tend to have more complex formation and maintenance requirements, and they don’t have the taxation advantages of an LLC. The corporation has some advantages of its own (for example, it’s easier to attract investors to a corporation) that make it worth a look, but the LLC is a simpler and more flexible business structure.
Can I serve as my LLC’s registered agent?
Yes. Every state allows entrepreneurs to serve as their own registered agents for their own businesses. However, while the registered agent’s role can seem like that of an unnecessary middleman, there is more complexity to this position than some people realize. For instance, you would need to be present and available at your business location during all standard business hours.
Why should I hire an LLC service when I can form my own LLC?
The do-it-yourself route is always an option for LLC formation. However, LLC services are so affordable that there’s really no good reason not to use one these days. In addition, some of these companies often throw in free bonus features that make them an even better bargain.
Need some additional information, check out our ZenBusiness vs LegalZoom page.
Should I form my LLC in my home state, or choose a state like Delaware or Wyoming?
Some people like to form their LLCs in states with favorable legal settings. For instance, Delaware is often seen as the most business-friendly state, as it has an entire court system that’s dedicated solely to business matters. As for Wyoming, this state has some of the most generous anonymity laws for LLC ownership.
However, for most people, the best option is to form their business in their home state. Forming in a different state can be a tremendous hassle and can also add unnecessary complexity to tax issues.
How much does it cost to form an LLC?
The costs of LLC formation can vary quite a bit depending on which state you’re forming one in. For in-depth information about LLC formation costs in your specific state, take a look at our guide to state-by-state expenses.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Written by Team ZenBusiness
ZenBusiness has helped people start, run, and grow over 700,000 dream companies. The editorial team at ZenBusiness has over 20 years of collective small business publishing experience and is composed of business formation experts who are dedicated to empowering and educating entrepreneurs about owning a company.
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