Unlike some real estate mogul, most people cannot obtain a small loan of $1 million from their father to start a business. For many people, it may be a good idea to start their own business while they are still employed. This tactic offers a cushion for new entrepreneurs to fall back on just in case things go awry with their fledgling business. This also provides a steady stream of income during the early stages when the vast majority businesses do not turn a profit. A limited liability company (LLC) is a business structure that allows business owners the benefit of flow-through taxation, where the income of the business entity is treated as income of the business owner, while still retaining the limited liability of a corporation. Having limited liability means that business owners are not personally liable for the debts of the company beyond their investment in the company.
LLC Rules and Regulations
Despite common belief, individuals are not forbidden to form an LLC while they are still employed by another company. The legal procedures to do so vary from state to state, but states do not look into employment status when forming an LLC. In other words, employment status at the time of forming an LLC is irrelevant, at least in the eyes of the state. But there are other issues to consider before one files to form an LLC.
Many employment contracts have clauses that make it harder for employees to form their own LLC on the side. Employees must be mindful of all the terms in their contract to avoid legal problems in the future. An employee's employment contract may give the employer ownership of all inventions and innovations created by an employee while on the job or with the use of the employer's resources. Issues of conflict of interest may also arise, especially if the new business would compete with the employer. A non-compete clause in an employment contract would prevent employees from opening a competing business while still employed. Furthermore, employment contracts may go further by prohibiting employees from engaging in outside work that may lead to conflict of interest. It is important to understand the specifics of their employment contract and the nature of their new business before starting an LLC while employed.
Should employees tell their employers that they plan to open a business while working? The answer to that is the same as the lawyer's default answer to almost all questions, it depends. Informing an employer may lead to questions of the employee's commitment to their day job. Employers would worry about the use of company time and resources going to this new business rather than towards the employee's duties. Even if no company resources or time is used, there is the possibly of decreased employee performance. Starting a business is extremely difficult, especially in the beginning stages. If an employee is spending a large amount of time on this new business the possibility of fatigue is extremely likely. On the other hand, the new employee's LLC may be able to conduct business with the employer's company. Being acquainted with the people who work at the employer's office gives the new business an edge in doing business with the company. Obtaining a customer immediately will allow the new business to build a track record and gain recognition in the industry. Employees should consider the benefits and risks of informing employers of their intent to form a side business.
Employees could choose to have their LLC taxed as a corporation, in which case, the corporation files and pays taxes as a separate entity from the new business owner. However, if the new business owner chooses not to have their LLC taxed as a corporation, then the LLC income will be reported on his/her personal tax return by filling out Schedule C to Tax Income Form 1040.
Starting a successful business requires a tremendous amount of effort on the part of the new business owner, which makes it hard to hold down their day job at the same time. It is vital to keep these two jobs separate from each other to avoid problems with the employer. Even though it is tempting for employees to work on business affairs while at their day jobs, it is not ethical or fair to the employer. Even simple tasks such as returning emails or phone calls related to the new business should be avoided. Usage of the company's resources, no matter how small, can land employees in trouble. Having an LLC while employed offers an extra margin of safety and capital; however, it comes at a cost of extra effort and caution on the part of the employee.