The big questions when starting a business is whether to incorporate or use a limited liability company.
From a legal stand point, a limited liability company, like a corporation is designed to protect the owner from lawsuits. Both structures do that job very well.
Until about twenty years ago when starting a new business people incorporated. However, within the last 20 years the new kid on the block, the Limited Liability Company or LLC has become increasingly more popular than a corporation. You should not pick one or the other on popularity but on what fits your particular business needs.
The corporation has been around for over five hundred years. We have an entire body of laws and judicial decisions which tell us how the corporation works. Since the LLC is a relative newcomer the body of laws governing them are not as mature and this can lead to problems.
The two main types of corporate structure actually have more to do with tax law, not corporation law. These are the “S’ Corps and the “C” Corps. The S Corp is a structure which allows the profits from the corporate to flow directly to the shareholder. In the C Corp, the corporation takes the profit, pays a tax on it, and the money flows to the share holders where it is taxed again.
As a general principle small companies can be S Corps but larger companies may have to take the C Corp structure. We have seen people getting improper counseling and wrongly chose one form over the other, generally resulting in fines and penalties. It is critical to discuss the issues of your business fully with your attorney so that the right structure can be chosen.
While many shareholders don’t sign a shareholder’s agreement, we would recommend that they do. We’ll address the shareholder’s agreement in-depth in another article. The take away here, is that a shareholder’s agreement is a contract between the shareholders. In the case of a dispute, it governs the relationship. Think of it as prenuptial agreement for business partners.
A limited liability company has different, and more expensive filing requirements. Also, to be properly run, the limited liability company needs to have articles of organization and an operating agreement.
The articles of organization is a detailed document which sets up the structure of the limited liability company and how it is to be run. The operating agreement is generally used when there is more than one member of the limited liability company. This is also a detailed document which sets forth the obligations of the members to each other and to the company. It should also set forth each parties ownership share of the company,how much new members must pay to join, and what happens if the members reach a deadlock.
The main reason people chose the LLC over the corporation has to do with how income to the owners is taxed. If it comes down to a choice between and S Corp and an LLC, our advice is have the accountant and attorney consult to see which one will work better for the client.