As of January 1996, only Hawaii and Vermont had not enacted a Limited Liability Company Act. In 1996 Hawaii passed a Limited Liability Company statute, and by 2008 Vermont had followed. Limited liability companies permit persons to operate a business in a manner virtually identical to a general partnership yet with the full corporate protection against personal liability for the debts of the company. A limited liability company is considered to be a legal entity which is separate and apart from all of the people who own, control or operate it. A limited liability company holds most of the rights of a legal person. A limited liability company is considered to be a legal entity which is separate and apart from all of the people who own, control or operate it. A limited liability company holds most of the rights of a legal person. A limited liability company can be taxed as either a corporation, or as a partnership. Clearly, it is better to be taxed as a partnership. Management and control of an LLC is vested with its members, who appoint a Manager. Owners of the limited liability company are called members and not shareholders, as in a corporation. Transferability of membership certificates could be difficult in that the rules to transfer are in the Operating Agreement of the limited liability company, as opposed to Bylaws in a corporate form. There are also different rules in different states as to how to operate the LLC. An entrepreneur using a limited liability company would want to find a structure that he likes in “some” state, and then use that company to do business, in whatever state he does business, and file the LLC as a “foreign LLC” doing business in that state. In doing litigation with a LLC, the laws are developing, and the judicial system is gaining experience in LLC litigation. This could be either an advantage or a disadvantage, depending upon one’s point of view. A limited liability company is probably a good structure for an entrepreneur, who is operating with his own money, perhaps trying to establish a great deal of privacy, or who is establishing multiple entities with different names, to mask the true size and scope of his business dealings. The entity is probably not the best to attract investor money; while there is no legal limit as to how many members the Limited Liability Company may have, for more than 35 investors, it would not be a very attractive vehicle in which to raise equity capital. In some cases an entrepreneur may need an “Aged” Limited Liability Company, instead of forming a new entity. For instance, a good use for a Limited Liability Company would be for a real estate entrepreneur to buy a larger property, i.e. an apartment complex or a commercial strip mall, with a few (less than 35) investors. With a new entity, it is possible the entrepreneur could have resistance from the title company in that the entity is less than three years old. Insurance companies do not like new entities, and banks like to look at three years of history. All of these objections have explanations, but sometimes it’s just easier to have an entity that is over three years old and not have to answer any questions.
The “C – Corporation” designation merely refers to a standard, general-for-profit, state-formed corporation. To be formed, an Incorporator must file Articles of Incorporation and pay the requisite state fees and prepaid taxes, if required. A corporation which is properly formed and operated as a corporation assumes a separate legal and tax life distinct from its shareholders. The importance of this point cannot be understated! A corporation prepares, files, and pays taxes at corporate income tax rates (IRS Form 1120). The owners of a corporation are called “shareholders.” A corporation can be formed with one shareholder. The shareholders elect the Directors of the corporation, whose responsibility it is to set policy for the corporation, hire and fire the Officers of the corporation, hire accounting and auditing firms, and generally watch over the corporation. Usually, there can be any number of directors for a corporation, as established in its Bylaws. If the corporation has one shareholder, it is possible to have only one director, and if two shareholders, then two directors. After three shareholders, the number of directors will be a practical number depending upon how big the business is, what it is doing, and what it takes in the judgment of the directors, to get the job done. Corporations may offer their employees unique fringe benefits. For example, owner-employees may often deduct health insurance premiums paid by the corporation from corporate income. In addition, corporate-defined benefit plans often afford better retirement options and benefits than those offered by non-corporate plans. This may change due to Obama Care and major revisions to the tax code in the near future. To retain the corporate existence and thus the benefits of limited liability and special tax treatment, those who run the corporation must observe corporate formalities. Thus, even a one-person corporation must wear different hats depending on the occasion. For example, one person may be responsible for being the sole shareholder, director, and officer of the corporation; however, depending on the action taken, that person must observe certain formalities. Annual meetings must be held, corporate minutes of the meetings must be written, officers must be appointed, and shares of stock must be issued to shareholders. The corporation should issue stock to its shareholders for consideration to be adequately capitalized to cover any foreseeable business debts. Where corporate formalities are not observed, shareholders may be held personally liable for corporate debts. Thus, if a thinly capitalized corporation is created, funds are commingled with employees and officers, stock is never sold and issued, meetings are never held, or other corporate formalities required by your state of incorporation are not followed, a court or the IRS may “pierce the corporate veil” and hold the shareholders personally liable for corporate debts. As a separate legal entity, a corporation is capable of continuing indefinitely. Its existence is not affected by death or incapacity of its shareholders, officers, or directors or by transfer of its shares from one person to another. A corporation may have an unlimited number of shareholders; some corporations have millions of shareholders and billions of shares outstanding. (General Electric has over 10 billion shares outstanding). A capital structure of a corporation can have different classes of Common stock, different classes and series of Preferred stock, different series of Debentures, and countless varieties of derivatives. The corporation is perhaps best used as part of a strategy to reduce personal liability. Since the corporation is granted by law the powers and rights necessary to conduct its business, the corporation can choose to engage itself in activities that, while not illegal, may subject the corporation to potential risk. It makes infinite sense, then, for any individual that is involved in any business or personal activity that has the potential for liability to incorporate those activities into a separate “legal person.” Strategies to reduce personal liability are perfectly legal. More importantly, they may also be a strict moral obligation of the “doers” of the world. Without these types of strategies, technological innovation is kept in a strangle-hold by the current legal and insurance systems that are in complete disarray over liability lawsuits. Like the “Aged” Limited Liability Company, an entrepreneur may want to acquire an Aged “Shelf” corporation, to merge his/her business into, to get a head start on the question, “how long has your business been around?” or “when was your business incorporated?” Some businesses do not like to extend credit, or to even do business with start-up companies, or companies that are not seasoned. Some examples are banks, bonding companies, insurance companies, or other financial service companies, and many potential vendors. Acquiring an “Aged” corporation and merging an operating business into it can be done fairly reasonably. The “Aged” corporation needs to be “clean” (no debts, no lawsuits pending, no other potential liabilities not disclosed) and at least be over three years old (older is better). The entrepreneur’s business has the “operating business”, a business plan, management, and (hopefully) adequate capital to fund the organization. The “Aged” corporation has the corporate age, history, and corporate structure, (and maybe some other shareholders). Southwest Business Consultants, Inc. has “Aged” corporations, and “Aged” Limited Liability Companies from three years old to twenty-seven years old. We have “Aged” corporations with one shareholder to approximately 100 shareholders. This process does obviously require some strategic business consulting to accomplish the immediate goals of the entrepreneur, but not go into “over-kill” to provide a shelf corporation to be “public” when the entrepreneur is either not ready for that, or cannot handle the costs or complexities of the “going public” process.
An “S” Corporation, which has many characteristics of a regular “C” corporation, was created by Congress to help small business. The main advantage of an “S” corporation is that the “S” corporation is treated for tax purposes as a partnership. The “S” corporation has the protection of a corporate form plus the right of the shareholders to participate in the business and have its income taxed as a partnership. The “S” corporation is limited to a maximum number of shareholders. The “S” corporation shareholders must all be individuals, who are U.S. citizens or permanent legal resident aliens. The “S” corporation may not have non-resident aliens, other corporations, partnerships, or trusts among its shareholders. In raising capital, this could be a huge problem. However, a small business could begin as an “S” corporation, and then if the business grew to the point it needed capital from more investors, it is possible that the “S” corporation could convert its status into a “C” corporation.
Summary In this short Memorandum, we have discussed the characteristics, similarities, and differences between General Partnerships, Limited Liability Partnerships (LLPs), Limited Partnerships (LPs), Limited Liability Company (LLCs), the “C” corporation, and the “S” corporation. As is obvious from the discussion, there are many uses for the different types of business formation methods. If one were to have several different product lines, in multiple states, it is conceivable that management would be looking to have the maximum flexibility, and pay the minimum in both state and federal taxes. What is it the management has, wants to accomplish, and wants to become? We do strategic business consulting and analyze the particular enterprises and develop a unique strategy to the requirements of our clients. There is no such thing as one solution fits everyone.
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