Considerations When Picking a Business Entity Type
When helping an entrepreneur with the start-up of a new business the first decision is which entity to form for the client. There are many choices including S or C corporation, limited liability company (LLC), or partnership.
A good business attorney will generally start the representation with an “interview checklist” which helps to narrow down and identify the best business type to meet the clients needs. The checklist will focus on 1) the parties involved in the business an 2) the business matters.
Are the owners of the entity individuals or other entities?
Will the owners be actively involved in the business?
What are the owners contributing to the capital of the business?
How will the entity be managed?
Type of business to be conducted?
Location of business?
Projected financial needs and expectation of the business?
Any tangible assets that require special treatment?
The initial interview is an important step in the type of entity chosen. While the attorney is making evaluation and making predictions of what the future may hold, the careful analysis at the outset is an important step in ensuring that the client’s expectations are met in the present, as well as, the future.
Main Considerations that will be Considered:
Limiting Personal Liability:
When limiting personal liability is a main concern for owners, an LLC or Corporation would be the preferred entity type. General or limited partnerships do not offer liability protection which makes partners jointly and severally liable for the obligations of other partners for their wrongful acts or breach of trust, as well as, other debts and obligations.
The capital structure of the entity is an important consideration and a practitioner should review the competing interests of various owners, as well as, how equity interest will pass thru estate planning techniques. Creating a flexible capital structure is an important step.
C Corporations offer a lot of flexibility in that shareholders can create different classes of stock which give preferential treatment to certain shareholders. In an LLC equity is determined by the membership interest and there is great flexibility given to member of an LLC in how they structure capital ownership.
Management and Governing Bodies:
In a corporation governance is generally managed by a board of directors which are elected by shareholders. LLC’s on the other hand are managed by members unless otherwise provided in the articles of organization. LLCs can be structured as member managed or manager managed.
For corporations, voting is generally based on the number of shares owned by a shareholder. However, in LLCs the general rule is that each member has an equal vote regardless of the members capital contribution. This can however be modified in the operating agreement which is often the case.
Corporations typically have a very rigid management structure and many find the simplicity of flexibility of running an LLC as a major advantage.
Reporting and Record keeping:
Both Corporations and LLCs are governed by the laws of the state in which the entity was formed. Corporations are typically required to hold periodic shareholder meetings and must give notice to interested parties. LLCs again have fewer and less formal requirements.
One of the key considerations for entity setup for owners is the tax treatment. For tax considerations it is highly recommended that a qualified accountant be brought in for part of the entrepreneurs team to ensure that all transactions and unique circumstances are being considered. In general entity taxation, state taxation, self-employment tax, deductibility of losses, and allocations of profits and loss will need to be considered.
Unsure of Which Entity is Best for You?
Picking the right entity to operate under is one of the first questions an entrepreneur must answer. Working with an experienced small business attorney is a great step. At Matt Devitt Law, PLC we will take the time needed to get to understand your immediate and long-term goals to ensure you and your teams are set up for continued success.
A bit about us – Matt Devitt Law is a full service small business law firm located in Livonia, MI. In addition to small business planning we also provide full service estate planning, as well as, a full suite of real estate legal services as well.
We work with our surrounding communities including Livonia, Northville, Plymouth, Novi, Farmington Hills, and beyond. Our focus is on providing pragmatic value based solutions for your estate planning, small business, and real-estate legal needs. Give Matt a call (734) 335-0713 for a free consult.
** This is not legal advice