As an entrepreneur, you understand the merits of your business better than anybody. Youve decided the next step to growing your business is to structure your business as a Limited Liability Company, Limited Liability Partnership, C Corporation, or S Corporation, but you arent sure which entity type is best suited for your particular business. What type of business entity should you form? This is an important decision that invokes a variety of nuanced decisions and must be specifically tailored to your situation. While an in-depth analysis is vital to such a determination, we discuss an overview of the business entity types.
Corporations are incorporated businesses that must have at least one shareholder and offer limited liability protection. They have shareholders, officers and directors. Shareholders are the owners of the company and elect the board of directors. The board of directors oversees and directs corporate affairs and decision-making. The directors elect officers to manage daily business affairs. Corporations are presumed to be for-profit entities, and as such, they may have an unlimited number of years with losses. Corporations are subject to internal and external corporate formalities and obligations, including the adoption of bylaws, filing annual reports, paying annual fees, stock issuance, and holding shareholder and director meetings. There are two types of corporations generally considered by entrepreneurs.
i. S Corporations
S corporations must have at least one, and no more than 100, shareholders. S corporations are pass-through entities, whereby profits and losses are passed through the business and taxed at the shareholder level. S corporations are limited to only one class of stock issuance. Only U.S. citizens and resident aliens may be shareholders of S corporations and S corporations cannot be owned by other S corporations, LLCs, C Corporations, partnerships or many trusts. But what is the difference between a S Corporation and a C Corporation?
ii. C Corporations
C corporations may be subject to double-taxation: at the corporate level and at the shareholder level. C corporations have far fewer ownership restrictions, as they do not restrict shareholder numerosity, the type/identity of shareholder, or classes of stock. Consequently, C corporations provide increased flexibility when starting a business if you plan to grow, expand ownership, wish to have institutional or foreign investors or sell your company down the road.
Limited Liability Companies
A limited liability company (LLC) is a flexible business entity enabled by state statute that merges the limited liability elements of a corporation with the tax efficiencies and operational flexibility of a partnership. Members of a limited liability company are given the same advantage of limited liability as shareholders in a corporation. LLCs are pass-through entities and therefore are not taxed as a separate business entity. LLC members are the owners of the LLC as much as shareholders are the owners of a corporation. LLCs may offer more flexibility than corporations in terms of how the management of the business is structured and may be dealt with contractually through an operating agreement. You may choose from two possible management structures.
You can choose to have a member-managed LLC where all the members participate in running the business, or you can have a manager-managed LLC where on designated members, or certain non-members (or a combination of the two) are given the responsibility to run the business. In a manager-managed LLC, the other members are passive investors who are not involved in business operations. Unlike corporations, LLCs do not face strict ongoing meeting and documentation requirements as these can be modified. LLCs may have unlimited number of shares and multiple classes of stock; however, there are stringent limitations and requirements on the sale of stock. On January 1, 2014, Californias Beverly-Killea Limited Liability Company Act was superseded by the California Revised Uniform Limited Liability Company Act (New Act) and includes substantive changes that you should review if you are considering forming a California LLC or if you are a member of a California LLC.
Limited Liability Partnerships
A limited liability partnership (LLP) provides limited liability protection to partners for certain partnership liabilities. Liability protection is state specific. Many states only provide protection to tort claims and do not extend protection to a partners own negligence or for the partners involvement in supervising wrongful conduct. Other states provide broader protection to partners, including protection against contractual protection claims brought by a partnerships creditors. LLPs are particularly well-suited to professional groups. In fact, certain states restrict this business form to certain professionals. LLPs generally protect each partner from the debts against the partnership arising from professional malpractice lawsuits against another partner. Partners are liable for filing personal income taxes and the partnership itself is not responsible for paying taxes. The credits and deductions of a LLP are passed through to partners to file on their individual tax returns.
Determining the structure that best suits your businesss needs is a complicated and important one. Many components comprise reaching a final decision. A seasoned attorney can be extremely useful throughout this process. To contact an attorney in San Francisco you may use this contact form here.
* The information contained herein does not constitute legal advice or establish the existence of an attorney-client relationship.