Whether to opt for a Corporation or LLC for your small or independently owned business is an entity question that most owners will need to address sometime during their business career. Some business owners know and chose an entity from day one while the majority do not and by default find themselves in a sole or partner proprietorship role with unlimited liability.
As their small business grows and changes and they become aware of the extent of their legal exposure they ask themselves: “Which entity is best for me?” This article is written from the perspective of a small or independently owned business owner.
In it I will provide a general overview of the similarities and the difference between these entities thereby giving you some information that will help you answer the question that was posed. To simplify the process the similarities and differences will be discussed under the heading found below.
Owning an LLC
The Limited Liability Company (LLC) issues membership units and its owners are called members.
The corporation, both C Corp and S Corp, issues shares of stock and the owners are called shareholders. In most cases both types provide a similar ownership structure; however, the difference is that the LLC allows for greater flexibility in that the owners can define different rights and obligations to members separate and apart from the membership unit.
For a corporation every share must represent an equal and identical unit of ownership. Corporations can issue shares that can be publically traded when and if the business becomes big enough and desires to go public. There is no option for public markets for an LLC. It is more suitable for privately held businesses.
Limited Liability Protection
Limited liability protection is extended to the LLC and the corporation as a result of their incorporation. What this means is that the members of an LLC and the stockholders of a corporation are treated legally as a separate and independent entity.
As such, any loss that occurs with the business is limited to the amount of your investment in the business and does not extend to your personal assets. Corporate principals have no personal liability for corporate debt, breaches of contract or personal injuries to third parties caused by the corporation, employees or agents.
While the corporation or LLC may be liable or responsible, a creditor is limited to pursuing only assets within the LLC or corporation to satisfy a claim; the assets are not susceptible to claims or seizure for corporate debt. The companion article (Click Here) goes into greater detail about the tax savings found in both the Corporation and the LLC.
The LLC can have a very simple single layer of management (known as member managed) or the management structure can be structured with a central governing body (manager managed). They have the choice basically to manage as they see fit and adopt a management plan and structure that will best meet their needs. The LLC is not required to meet the same level of formalities and paperwork as a corporation.
Members (i.e., owners) and managers may act informally, that is, without formal meetings and without documentation. Every LLC has an operating agreement and as a safeguard should at least document their structure and business practices, follow their state guidelines and file their annual/biennial reports or renew their business license.
“Decisions by members and/or managers may be made informally and neither formal meetings nor documentation of ordinary-course decisions are required. Consider requiring formal meetings (and documenting the decisions) for certain actions, such as: amending your operating agreement, borrowing money, tax decisions (e.g., S Corporation election or §754 elections), encumbering property, sale of assets, or admitting a new member. But mandatory regular or annual meetings should be avoided.”
The key point is that the LLC has great flexibility in deciding how they wish to be managed and what rules to impose on the business without worrying about formalities, maintenance and paperwork. In some states they are even allowed to comingle funds but good business practice calls for a separation of personal and business income from my accountant’s perspective.
The Board of Directors
The corporations are mandated to have a central body of management structures and they accomplish this with a Board of Directors. Every corporation has a Board and its members are elected by the shareholders to serve terms. Corporate officers typically consist of the President, Vice president, Treasurer and Secretary.
The Board has the authority to manage the company but typically they hire officers to execute the daily operations in concert with the decisions made by the Board. The general shareholder does not have management authority. Corporations are mandated to follow “Corporate Formalities” which includes the following:
- An accurate account of all meetings by the board or special meetings with the shareholders. The corporate Secretary is responsible for the care and accuracy of all the minutes of these meetings.
- There is to be no comingling of corporate funds.
- The Board of Directors must meet at least once a year. These meetings are required by all 50 states and are formal meetings during which important strategic corporate decisions are undertaken such as: large acquisitions, mergers, contractual agreements with other entities, etc. It is usually at these meetings that decisions regarding the corporate leadership are addressed, where officer positions are affirmed, changed and even a chairman or CEO is appointed.
- All contractual agreements entered into by the corporation at the corporate level must be memorialized in writing, with the express consent of the Board of Directors. This includes all financially-binding agreements, acquisitions and employment.
Failure to adhere to the corporate formalities will often lead to a weakening of the asset protection and limited liability protection with commensurate consequences. The LLC, in contrast to the corporation, is like a flexible shell when it comes to management. It can start out with a blank slate and define how it wants to be governed based on the specific and special circumstances. No wonder small business loves this entity.