Professionals have a wide range of corporate bodies to choose from when starting their business, such as corporations, limited liability companies (LLCs), limited partnerships, limited partnerships, general partnerships, and sole proprietorships, each with their own set of advantages and disadvantages. The right entity depends on the priorities of the owners. Do the owners want to participate in the running of the company? Would you like to adapt agreements with co-owners for a specific project? What about their personal liability or how much tax they or the company pay? It is important to start and answer these questions in order to determine the right fit for the company and its owners. This article examines the characteristics of the two most common forms of business to aid this analysis: corporations and LLCs.
The traditional corporate form is the corporation, with the usual corporate trappings – shareholders who own the company and the board of directors who run it. Being a shareholder has its advantages. They seldom participate in the running of the business, owe no fiduciary duties to society or anyone else (except for closely held corporations), and are shielded from personal liability for the company’s debts in excess of their deposits while reaping the profits of the group. Shareholders can also freely transfer their holdings at will, unless otherwise agreed. Minority shareholders in closely held companies are granted additional protection, including investment rights, profit rights and voting rights. Even if the shareholders do not run the company, they elect the directors to do so. These directors cannot run and run the company as they see fit, but must discharge their fiduciary obligations to both the company and the shareholders.
The typical form of a corporation is a C corporation, but it has one major disadvantage – it is subject to double taxation. Taxes are first levied by the corporation itself and then again by the shareholders when corporate profits are distributed through dividends. The 2017 Tax Reduction and Employment Act reduced the corporate income tax rate from 35% to 21%, but the double taxation characteristic remains.
The corporate answer to double taxation is the S corporation. S companies are hybrid companies in that they are run-through companies for tax purposes (such as LLCs and partnerships), but are still companies that are governed by state laws with traditional company formation concepts (e.g., articles of incorporation, articles of association, stockholder agreements, etc.). Not every company can choose to be treated as an S company. Only small companies that can meet certain criteria are considered to be S companies. B. do not have more than 100 shareholders.
LIMITED LIABILITY COMPANIES
LLCs have become the preferred form of business since Wyoming passed the country’s first LLC legislation in 1977. The three main advantages of LLCs are individual taxation, limited liability, and flexibility. If the right choice is made, LLCs are transit companies where taxes bypass the companies themselves and are imposed directly on their owners. Owners also have limited liability, regardless of whether they are involved in the running of the company or not. In contrast, members of certain partnerships are liable for the company’s debts and liabilities. In addition, due to the freedom of contract, LLCs offer flexibility in corporate governance. The owners are free to enter into the operating contract (also known as “GmbH contracts”) as they wish. Indeed, freedom of contract is an important political issue for states that enact LLC laws. For example, Delaware’s Limited Liability Company Act affirms that freedom of contract is one of the driving forces behind it – “It is the policy of this chapter to give maximum effect to the principle of freedom of contract and the enforceability of limited liability companies.” 6 Del. C. § 18-1101 (b) (2021).
With freedom of contract, business partners can enter into contracts at their discretion regarding governance in a particular LLC. This means that business professionals can customize LLCs to suit their particular circumstances and business purpose. You can remove safeguards provided by state law, such as fiduciary duty or business opportunity, or owner consent to certain transactions. You can restrict the transfer of ownership shares or provide pre-emptive rights. In the event of a dispute, they can order arbitration or mediation prior to formal legal proceedings. The possibilities are endless for what LLC owners can agree on in terms of corporate governance.
However, such benefits are not without risk. Without mandatory protection given to businesses, less experienced owners in an LLC can take away the desired protection given to businesses in general. Contract law also applies, including the law on the interpretation of contracts. Therefore, special attention should be paid to the drafting of company agreements to ensure that no provisions are deleted due to ambiguity. An agreement to agree on a certain subject in the future is also not an agreement at all. It is always recommended to identify and confirm as many terms as possible in the present rather than getting the subject on the move and risking the very real possibility that no agreement will be reached.
Establishing a company is an exciting time for owners and entrepreneurs. But that excitement shouldn’t rush into the all-important decision of what type of company to adopt. This may not be imaginable at first, especially in the hustle and bustle of an emerging business, but it can lead to disputes between owners. The first step in resolving this dispute, whether it is a legal dispute or not, is always a review of the company formation documents to determine the rights, obligations, duties and obligations of the parties involved and the strategy for further development to inform. It’s important to get it right in the beginning.