When is the right time to create an LLC?

June 21, 2026

By Nadia Cabrera-Mazzeo, Esq.

Small businesses often start as sole proprietorships/ partnerships until a point when the owners decide they need a formal business entity. People often create an LLC before they’re ready, which can be messy an ineffective, especially when there is more than one owner involved.

A premature LLC can be ineffective because an LLC means nothing without proper business practices that strengthen the liability shield (a judge will pierce the liability shield and dip into the owner’s personal pocket to pay business debts). It can get messy because an ownership interest in an LLC is an asset like owning a home, and must be accounted for even when there isn’t much money flowing through it. One business developer with the Small Business Development Center (SBDC) likens a co-owned LLC to a marriage. It binds business partners together. It’s easy enough to get into, but less straightforward to get out of.

There is no question that a large-scale business needs its own legal identity. But the lines are blurred at a small scale. So how do you know when you’re ready for an LLC? It all depends on the risks involved. Here are some factors consider:

1  Your business is making money

If your business is not making any money and likely won’t for a while, then the risk of someone suing your business or otherwise demanding money from your business is very low. Borrowing money to get a small business going will likely also require a personal guaranty—a promise to pay out of pocket for the loan if the business can’t pay it back. An LLC’s liability protection will not make a difference when there is a personal guaranty.

However, if your business is making money, it may be able to incur debt in its own right. Engaging in revenue-generating activities that bring in significant sums raises the stakes if something goes wrong. A revenue-generating business could also be eligible for tax savings only available to formal entities.

There is no official financial threshold for when to create an LLC. One sure sign is if your business would be eligible to be taxed as an s corporation by making enough to consistently pay you. LLCs have a lot of flexibility on how they are taxed. If an LLC chooses to be taxed as an s corporation, then the owner becomes a W-2 employee and can save on self-employment taxes when taking additional profits.

2  Your business is in a high-risk industry

A high-risk industry means the industry is highly regulated (e.g. healthcare, finance, energy, transportation) or there is a high likelihood that someone will accidentally get hurt (e.g. sports, food sales, mass market product sales). Insurance is typically the first line of defense with these high-risk endeavors, but an LLC or other entity type that protects the owner(s) is also essential.

3   You have or soon will have employees

As soon as you hire an employee, you are thrust into the world of employment law and regulation. Remember, higher regulation means higher risk. Higher risk means you’re better off with an LLC.

4  You are entering into big contracts for your business

Again, the size and value of the contract, especially how much money is at stake if something goes wrong, will matter when deciding whether you should do it through an LLC. Also think about who you’re doing business with. Is the other party a commercial entity with a team of lawyers? The volume of contracts can also make a difference. Even low-value contracts can add up to significant exposure.

Doing business without a formal entity like an LLC or corporation is still a valid way to do business and may work well even in the long run for low-risk businesses. Creating an LLC very early on may not be the right move if you’re still finding your way and are not certain that your business partners will stay along for the ride. But always be mindful of the risks you’re taking on and certainly don’t wait to form an LLC when the stakes start to rise.

Law office of Nadia Cabrera-Mazzeo, Esq.

Small business and contracts lawyer

Based in Taos, serving clients throughout New Mexico

505 427 2025

nadia@honestcontracts.com

The information on this website is not legal advice and does not create an attorney-client relationship. The rates and fees listed on this website may not be the most up to date.