Advantages and Disadvantages of Private Limited Companies

Most of the advantages and disadvantages of structuring your company as a privately held, limited liability company can be attributed to the company's status as a closely held company. Limited liability companies are structured similar to limited partnerships. Its shareholders are referred to as members. Like partnerships, LLCs are treated as pass-through entities by the Internal Revenue Service and no income taxes are paid at the corporate level. Any other advantages or disadvantages of a particular LLC are dictated by how the Membership Agreement is drawn up. Also, depending on the dynamics of the LLC's ownership structure, what some members may view as advantageous, others may view as disadvantageous.

Advantages

Privately held companies are not required to disclose financial statements to the public. These expenses increased with the passage of the Sarbanes-Oxley Act, which mandated rigorous risk management and internal reporting requirements, particularly for public companies. According to one Securities and Exchange Commission study, the average cost for public companies directly attributable to Sarbanes-Oxley requirements was $2.3 million.

Other disclosure costs affecting public companies that private companies avoid include stock price volatility associated with financial disclosures. When publicly traded companies report quarterly and annual financial results, any shortcomings can result in the stock dropping substantially. Also, private companies are subject to less pressure from outside entities regarding the company's management. This reflects another advantage: it is easier for private companies to retain corporate control, because no one can purchase their shares on the open market, which is necessary to gain seats on the Board of Directors.

Disadvantages

Illiquidity risk is one of the most significant risks associated with ownership of private LLC interests. Illiquidity refers to the ease with which a shareholder can dispose of his shares. Investors value liquidity because it provides critical financial flexibility and the ability to minimize losses. All else equal, illiquidity risk reduces the value of closely held stock by an average of approximately 20 percent to 25 percent.

Private companies are generally smaller and have less access to capital markets. This increases the company's costs of raising capital, which is exhibited in higher interest rates on bank loans, and higher transaction costs in the event the company participates in a private stock offering.

Conclusion

It is difficult to generalize regarding the perceived benefits of structuring a company as an LLC, because management's interests are not always perfectly aligned with those of other shareholders. This is particularly true of very small companies. This is referred to as agency risk. Look at each company's ownership structure, the Membership Agreement, dividend policy and overall financial performance in order to identify genuine advantages or disadvantages on a case-by-case basis.