Considerations in Choosing an Entity
Tax costs, liability exposure, and the practical convenience of various forms of business are the points that most clients raise when they consider setting up a business organization. Different types of ventures require different organizational means: the sole proprietorship, the general partnership, the limited partnership, limited liability partnership, the limited liability company (LLC), and the corporate form are all possibilities. Even within the corporate structure, many different kinds of operating procedures are possible.
A new and risky business, or one in which losses are sustained to build capital value, frequently are operated in an unincorporated form, or partnership form, so that any losses may be applied against income and offset with tax savings. A form of incorporated “partnership”, known as an “S Corporation,” may also be utilized. Subchapter S status avoids income tax at the corporate level, and corporate operating losses can be claimed by the shareholders. An LLC may be taxed like a partnership or a corporation, and provide liability protection to its members and the structure may protect the LLC from the personal liability of its members. Where the venture is speculative, and you do not want the risks associated with an unincorporated form, IRC Section 1244 stock may be issued. These tax questions should be discussed with you CPA or tax advisor.
The actual mechanics of forming the entity selected are quite straightforward. Many require a Certificate of Formation be drawn up, and filed with the Secretary of State along with a filing fee. Unfortunately, that is where a lot of people stop.
Corporations require that Articles be filed with the Certificate of Formation. Once the Articles are properly filed, the Secretary of State will issue the Corporate Charter and the corporation will have come into being. The corporate seal, share certificates, stock ledger, and minute book are purchased items.
A CPA will frequently offer to “incorporate you” for a nominal charge or no charge, plus filing fees, and may even order the corporate seal and minute book for you. That is, they will take care of the mechanics of forming a corporation. But that’s usually where it ends. In most instances there are many other steps required, which the CPA may not be aware of or be prohibited from doing, in order to build the corporate shield and give the corporation substance.
LLCs are controlled by their Operating Agreement or Company Agreement. The Secretary of State does not ask if you have prepared the Operating Agreement before filing the Certificate of Formation. What is in that Operating Agreement will depend on many different factors. Will the LLC be member managed, or manager managed? Will there be multiple members, or a single member? If you have multiple members, what happens in the event of death, divorce, disability or disgust (someone just wants out)? Will members be able to call additional capital, etc?
A business lawyer, on the other hand, will help you select the right type of entity for your needs, and make sure that you have done all of the steps necessary to properly set up your entity. They will prepare and file your Certificates of Formation, file Articles if needed, prepare your Operating Agreement or bylaws, order the seal and book, prepare the publication of notice to creditors if required, prepare the organizational minutes, and original issue of shares or unit interests. They can assist you with the with purchase and sale documents between the proprietor and the new entity, prepare buy-sell agreements if needed, and instruct you on what needs to be done to properly maintain the entity and limit liability exposure.