A Doing Business North America (DBNA) Case Study: The Cost, Time and Procedures for Filing LLC Applications and Sub-optimal Corporate Models for Startups

As of late, the economic climate has gotten significantly more risky for starting a business. Although the federal government still predicts middling economic and job growth for the coming year, with the Federal Reserve predicting GDP growth of 0.8% from 2023 to 2024, the collapse of Silicon Valley Bank and Signature Bank in mid-March and the increase to a 5% interest rate over the past 2 years has restricted access to capital for startups across the country. In this uncertain lending environment and with the prospect of rising interest rates on loans, making sure that startups have as much liquidity as possible has become increasingly urgent. In light of these developments, state and local governments should adopt policies that not only facilitate easy and inexpensive entry into the market, but also mitigate the harm that entrepreneurs may face in exiting it. One of the best ways to do this is by lowering the costs and time to complete Limited Liability Corporation (LLC) applications, which would increase both the number of new business applications and the actual number of new businesses on the margin. However, before we get ahead of ourselves, it is important to understand the makeup of how businesses are structured, how the structures differ, and how these differences play out in the business environment.

According to the Small Business Administration, there are 8 types of commonly-used business structures available for people wanting to start their own business: Sole Proprietorships, Partnerships, LLCs, C Corporations, S Corporations, B Corporations, Close Corporations, Nonprofit Corporations, and Cooperatives. While this might seem like a lot, the primary differences between them all are how they structure their liability and taxes. For instance, Sole Proprietorships and Partnerships are so-called “pass-through” tax entities. This means that the entrepreneur pays income, social security, and medicare taxes instead of corporate income taxes, which can be at a much higher rate. However, these two business structures are also subject to unlimited personal liability if the business goes bankrupt. This means that if a business does fail, which over half do within two years of their founding, the owner is on the hook for paying off the business’ debts, including her personal assets.

In contrast, the various corporation types separate the owner’s personal assets from the corporation’s debt obligations, meaning that they will not be personally ruined if the business goes bankrupt. However, this limited liability comes at the cost of paying corporate income taxes, which may be much higher than the self-employment and personal taxes that the business must pay. C, S, B, and Close Corporations play around with this tax structure and each have their own advantages and disadvantages. For example, C corporations are allowed to issue stock to raise capital in addition to regular lines of credit, which has the advantage of attracting investors and increasing the company's overall growth potential. However, C corporations face double taxation, as both corporate profits and dividends paid to shareholders are subject to taxes.

LLCs offer a middle ground between pass-through entities and traditional corporations, providing protection of the entrepreneur’s personal assets like corporations, while allowing for pass-through taxation that shields the owner from paying corporate income taxes. These combined benefits allow entrepreneurs to take bigger risks with their business ideas, leading to unconventional business models that drive innovation. More importantly, however, they also provide flexibility that is often crucial for startups navigating the unpredictable landscape of a competitive marketplace. As startups grow and evolve, LLCs give business owners an easy way to restructure and adapt to changing business needs. The flexible management structure of an LLC permits owners to make quick decisions without adhering to the strict rules and formalities that traditional corporations must follow. 

However, none of these advantages or disadvantages matter if the costs in money and time to form an LLC are prohibitive for entrepreneurs. After all, almost a third of business startups begin with less than $10,000 in initial capital, and many entrepreneurs rely on personal savings, friends, and family for financial support in the early stages of their operation. Similarly, an entrepreneur spending too much time on bureaucratic processes could miss crucial market opportunities or lose momentum in their business development. Furthermore, there is also the fact that people usually prefer the path of least resistance, meaning that many entrepreneurs simply choose the government’s default business model, which is as a sole proprietorship. Indeed, over 74% of all small businesses are registered as sole proprietorships. All of these factors are not only costly in themselves, but also create significant opportunity costs. Every dollar spent on an LLC application is a dollar not spent on equipment or staff. Every day focused on filling out business applications is a day not spent focused on developing products or services, building relationships, or refining the business model. 

These kinds of costs can be seen in the data from the Doing Business North America (DBNA) report. For instance, the states of Massachusetts and Nevada had the highest costs of LLC incorporation in the United States in 2021, at $500 and $475 respectively. This means that around 5% of all an entrepreneur’s starting money in those states is spent filing these forms, assuming a business has access to $10,000 in initial capital. Similarly, the states of Maryland and New Hampshire took on average 42 and 30 days, respectively, to process the paperwork for incorporating an LLC in 2021. This in turn plays into the number of procedures needed to file an LLC application, which can range from 2 steps in Kansas, up to 7 steps in New York state. Furthermore, these are base costs, times, and procedures that do not account for additional steps and costs that might be required for the LLC to become active, such as publishing costs, name registration costs, document correction costs, and legal fees by organizations that specialize in helping entrepreneurs with incorporation.

Looking at the impact of LLC application costs and processing times on their Starting a Business and Ease of Doing Business scores underlines this point. Preliminary analysis found that decreasing the cost of filing an LLC by only $1 is associated with 0.089 point increase⁽¹⁾ in a city’s Starting a Business score. Similarly, decreasing the number of days to process an LLC application is associated with a 1.26 point increase⁽²⁾ in a city’s Starting a Business score, while decreasing the number of procedures to incorporate an LLC is associated with a 6.22 point increase⁽³⁾ in a city’s Starting a Business score. While caution is necessary when extrapolating connections based on a single year of data, these findings suggest that reducing the costs, processing times, and number of procedures for incorporating an LLC can make it a more viable option compared to others. This in turn would generally have a positive impact on the ability of entrepreneurs to start a business in a given city.

In Arizona specifically, streamlining the LLC application process by reducing processing times, lowering application costs, and simplifying steps would significantly improve the state’s business climate. Although Arizona promotes itself as a business-friendly state, its capital, Phoenix, ranked 73th in the Starting a Business category and 49rd in the Ease of Doing Business category among DBNA’s 83 cities. Improving Phoenix’s rankings could be achieved with minimal changes. For example, reducing application fees from $50 to $40 and changing to a one-step application process by moving the application process entirely online to shorten LLC application processing times would increase Phoenix's Starting a Business rank 44 places to 5th in the country, and its Ease of Doing Business rank 72 places to 1st in the country. Furthermore, as the rules and bureaucracy for LLC applications are controlled by the state government, changing them would not only boost Phoenix’s rankings, but the rankings of all cities in Arizona.

In short, Arizona, as well as state and local governments across America, can create a more robust and efficient business environment by reducing costs, processing times, and the number of procedures for LLC incorporation. Simplifying the LLC business application process would not only promote innovation and economic growth, but also create a more inclusive environment for aspiring entrepreneurs from diverse backgrounds. By embracing the benefits of LLCs, startups can become more resilient in the face of economic challenges, contributing to local economic stability and sustainable growth. Ultimately, by supporting entrepreneurs and making LLC formation more accessible, governments effectively cultivate an environment that encourages innovation and economic diversification, which in turn fosters long-term stability and growth within their communities.

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⁽¹⁾ +/- 0.009 point margin of error

⁽²⁾ +/- 0.19 point margin of error

⁽³⁾ +/- 0.78 point margin of error

On 5/19/2023, this research note was updated to reflect corrected data from the DBNA 2022 report.