Software development is a huge and growing industry, worth nearly half a trillion dollars in the U.S. alone. If you’re joining the industry and starting your own software development business, you’ll want to get off to a good start by properly setting up your business entity. A limited liability company (LLC) is a common choice for startup founders because of the personal liability protection and pass-through taxation that it offers, as well as management flexibility.
Opening an LLC involves many steps, which are detailed in this guide.
Name Your Business
You’ll first need to choose a name for your software development business that’s easy to remember and unique. The name will also need to follow your state’s LLC name regulations, which differ by state, but generally prohibit the use of certain words like bank or university, or words that could confuse your business with a government agency. Your LLC name must also include an identity such as “limited liability company” or “LLC”.
Once you have a name, you’ll need to check your Secretary of State’s website and the United States Patent and Trademark Office’s website to make sure the name is available.
Select a Registered Agent
In nearly all states, you must appoint a registered agent for your LLC, which is an individual or a business that will accept official correspondence on behalf of your software business. You can elect to be your own registered agent, but that comes with the stipulation that you be personally available at your registered address during regular business hours, which can be restrictive.
Alternatively, you can appoint someone like your attorney or a professional registered agent service as your LLC’s registered agent. A registered agent service will receive your correspondence and notify you, usually by email, and then make any important documents received available to you online.
Decide on a Management Structure
In some states, when you officially form your LLC, you must disclose your management structure, which can either be member-managed or manager-managed. If all members of the LLC are going to play an active role in running your software company, your LLC will be considered member-managed. If only some members will be managers while others are silent partners, your LLC will be manager-managed. In a manager-managed LLC, non-members can also be hired and appointed as managers.
Register With the State
Next, you’ll officially register your new LLC with your state, which requires filing what’s usually called the articles of organization. On the document, you’ll include your software development business name and address and the name and address of your registered agent. In some states, you’ll also include your management structure and the names and addresses of the managers.
Often, entrepreneurs pay for an LLC service to handle the document filing for them to ensure that it’s done correctly. Some of these services, however, offer a free LLC formation plan that comes at a cost of state fees only, which range from $40 to $500.
Draft an Operating Agreement
Only five states require that you have an LLC operating agreement, but even if your state does not have the requirement, it’s important to have one in place for your software business. An operating agreement spells out the ownership percentages of members and how they receive profit distributions, and it contains many other critical provisions for your LLC.
Many business formation services offer operating agreement templates that you can customize, but often it’s a good idea to have it drawn up or at least reviewed by your attorney.
Choose a Tax Status
While by default, an LLC offers pass-through taxation, meaning that LLC profits pass through to members for tax purposes rather than the LLC itself being taxed, you can elect to have your LLC taxed as an S-Corporation. It’s sometimes beneficial to do so because an S-Corp can help you to avoid some self-employment taxes. Usually, this benefit will come when your software development business reaches a certain level of income, but when to choose S-Corp status involves complex calculations, so it’s best to consult with your tax advisor.
S-Corp status comes with certain IRS requirements and can be elected by filing Form 2553.
You have just a few things left to do at this point.
1. Obtain Business Licenses and Permits
Your state and local governments may require certain business licenses and permits, so you’ll need to check with your government offices for requirements. A software development business is unlikely to have many requirements, but you need to make sure you cover your bases. You may need a sales tax permit in some states depending on the nature of your software business and what is taxable in your state.
2. Apply for an EIN
If your LLC has multiple members or you have employees, you’re required to apply for and obtain an Employer Identification Number (EIN) that is a tax identifier for your business. Some banks also require that you have one when you open a business bank account. The application process is quick, simple, and comes at no cost on the IRS website.
3. Insure Your Business
You should protect your software development business by obtaining business insurance, including general liability and professional liability insurance. You may also want to insure your business property and equipment. Sit down with your insurance agent to discuss insurance options and get their recommendations.
4. Open a Business Bank Account
When you have an LLC, it’s very important to keep your business finances separate from your personal finances, so be sure to open a business bank account. If you co-mingle your business and personal funds, it could blur the line that separates you, the LLC member, and the LLC itself, which might threaten your personal liability protection in some situations.
Most banks offer business bank accounts, so check around to explore your options.
Opening an LLC is an important step in getting your software development business started, and it’s important to do it correctly by going through the whole process described in this article. A business formation service can usually help you with most of the steps, so it’s worth considering. Check around for a service that meets all your needs and that comes at a competitive price. You should also check reviews of the service to make sure you’ll get the support that you need.
Once you’ve completed the process, you can focus on launching and growing your successful software development company!