#entity choice

[ekremdum-blog]

How founders should think about choosing a business structure, weighing liability, taxes, and the ability to raise money against the company's actual goals.

Choosing a Business Structure for Your Startup

[principledlaw-blog]

THE MOST POPULAR ENTITY ON THE PLAYGROUND

We are taught in the most basic business law courses about the various types of entities available to individuals endeavoring to become the boss of their own slice of the American pie.  It is law school 101.  Much of the focus centers around corporations and partnerships, there is mention of the limited liability company (LLC), the professional limited liability company (PLLC) and the sole proprietorship.  Yet in practice, outside of the classroom, one entity reigns supreme: LLC.  Many of our clients sit down already convinced that the LLC is for them.  Some may not even understand why, but this popular business entity has taken over the small business playground.  Here’s why.

Then there was the sole proprietorship.  For the tentative small business entrepreneur acting alone a sole proprietorship was an easy option.  There are no papers to file with the PA State department, no required formalities and taxation is easy.  The owner simply has to report any activity on their personal tax return.  However, the sole proprietorship has no separate legal existence from its owner and therefore the owner is solely liable for the debts of the business.

And when the owner wasn’t acting alone?  There were the partnership options.  They are similar to a sole proprietorship, but available for two or more parties endeavoring to carry out a business for profit.  Like the sole proprietor, general partners are individually liable for the debts of the business.

Then in the late 70’s along came the LLC.  Like the new kid in any institution, there was hesitation among the masses, but now the LLC is recognized by many as being the most sensible structure for any small business.   A big selling point is, like the corporations, the LLC offers its owners protection of their personal assets; making the sole proprietorship and general partnership structures almost obsolete.  Like the S corp, it is a pass through tax entity, so owners avoid the double taxation of a standard C corporation.  Yet, unlike the corporate structures, the small business owner is not required to understand or implement the many external and internal formalities that often seem burdensome on top of the trials and tribulations of a new business.  In fact, in the past many small business owners found themselves out of compliance with the required practices involved in the operation of a corporation.  While LLCs are still encouraged to implement certain formalities, such as an operating agreement and proper maintenance of transaction records and agreements, there is flexibility in this entity.  Many of our clients find the LLC is the preferred entity over the S corp, because there is no limit on the number of permitted members and, for our international clients, members are not required to be U.S. Citizens or residents.  The only drawback, which may not be a drawback at all, is that LLC is not the entity to use if you eventually want to take your company public.  And, as a recent NPR article pointed out, some business owners don’t see going public as the “badge of honor” it used to be.

So why is it that the LLC is the most popular entity on the small business playground?  It is a pass through tax entity, which offers protection to its owners from the business’ debts and liabilities.  It allows unlimited members from the U.S. to Canada to Italy to South Sudan.  There are suggested, but not cumbersome formalities and members have the flexibility they need to run their business their way.  So what’s next for the amazing LLC?  What may prove to be an equally popular but more sophisticated offspring: the Series LLC.  Stay tuned to find out more.

For a consultation to determine if an LLC really is the right structure for your business or to begin the formation process, please call Samantha R. Lyons of Tiagha & Associates  via telephone at 267.322.6776 or email her directly at [email protected]. Please visit us online at www.tiaghalaw.com. We look forward to serving you.

[safdiepllc]

CD's for Questions #1: S-Corps vs LLC's

Question: Any reason to incorporate as an S-Corp rather than LLC (in NY)?  Other than cost of publication?  Tweeted out by: @jasongelman.

CD Saved: Think About Life, "Family."  For the whole "CD's for Questions" explanation, see here.  

[First things first: if a startup will be seeking VC financing, they should know that prior to closing that financing, the startup will have to be a c-corporation.  VC's will not invest in pass-through entities, like LLC's and s-corps.  Delaware law makes it easy from a corporate perspective to convert these NY entities into a Delaware c-corp (the state preferred by VC's).  Plenty of startups initially form their entity as a pass through, take the benefit of the losses on their personal income taxes and then convert prior to a VC financing.  However, depending on the business, there may be adverse accounting ramifications to a conversion.] 

I generally favor LLC's because of their flexibility.  As products of the 90's, LLC's tend to have less corporate formalities than corporations: internal governance and economic understanding among the members tends to be more the result of contract law, set down in the entity's operating agreement.  

As a result of its recent vintage, there are some uncertainties with respect to the LLC form.  For instance, how much in the way of fiduciary duties can a NY LLC contract away?  These issues are still being litigated; legal blogs are atwitter with recent Delaware case law on this issue.  

On NY's LLC publication requirement, depending on the circumstances, I may advise startups not to comply.  More detail can be found here.   

S-Corps tend to be more rigid and limiting.  For instance, there can be only one class of shares in an s-corp.  An investor cannot be issued equity with any economic or control preferences as compared to another shareholder.  The number of shareholders in an s-corp is capped at 100.  No foreign shareholders are permitted.  And only individuals can own shares of an s-corp.    

The one advantage I've found with an s-corp is a potential savings in the self employment tax.  For a good description of how it works, see here.  But I know other accountants who are not comfortable with the trick.

Again, I generally favor LLC's, but I've seen other skilled advisors go the s-corp route.

Think About Life, "Family."  I discovered Think About Life on an online blog and since then have caught them live around half a dozen times.  Each time is a better dance party than the last.  You can cancel your gym membership.  "Family" is their sophomore release;  this CD is from the Canadian pressing on Alien8 from May 2009.  Standout track: "Havin' My Baby." 

@jasongelman: Sweet tunes are coming to you!  Wife Safdie sends her gratitude.