Many new business owners come in not truly knowing exactly what type of business entity they want to form. This is one of the most important decisions a new business owner must make. Where it is possible later on to convert to a different type of entity, the structure that is initially set up can make the ability and process of conversion a complicated one. The two most common types of formations that are seen are corporations (Inc.) and limited liability companies (LLC). Both entities have pros and cons in the formation of each. However, it is important to understand both entities and their structure in order to make an informed choice about what is best for the business you are attempting to form.
The first difference between a corporation and an LCC is the management structure of each. An LLC is owned by members who have flexibility in deciding what management structure they are going to use to govern the LLC. For example, the owners themselves can elect to manage the company themselves, making the LLC a member-managed company or the members can elect to use non-members to manage the company, making the LLC a non-member managed company. Both options are available to an LLC and the decision for the members can be made based on what level of involvement they want to take with the management of the LLC. This flexibility can be very enticing to business owners. A corporation on the other hand, is managed by a board of directors. The corporation can choose specific managers to run the day to day operations, but the overall management of the corporation is dictated by the board of directors who have voting and operational rules that must be followed in accordance with Texas Law and/or bylaws that are put in place by the corporation. In a corporation, the owners are known as shareholders. These shareholders are like members in an LLC, but unlike them in that the shareholder has a much more passive role in the management and governing of the corporation. A shareholder may be entitled to a portion of the profits of the corporation (depending on the stock structure of the corporation), and only have the right to vote on issues that substantially affect the corporation. For a business owner who wants to take a more present, active role in the business, the management structure of a corporation may not be the best fit. It is important to discuss the differences in management structure with every client to best determine the right business entity fit for the client’s vision and goal of the business they are forming.
Another important aspect to discuss with a client is the difference between how the entities operate. An LLC has flexibility in deciding how the company will operate. Texas law does not force members of an LLC to follow strict corporate formalities. For example, an LLC does not have to keep minutes of a meeting or execute an operating agreement. A corporation, however, is required by law to fully comply with very stringent corporate formalities. For a business owner who wants flexibility, showing the owner the differences between an LLC and a corporation is beneficial in guiding them towards the right entity to form.
No matter how long or how short a business is in existence, the possibility of being sued is very real. This is something that must be discussed with each client. The last thing anyone would want is for the entity to be sued and not have the proper protection because options for formation were not properly laid out for the business owner. The good thing about an LLC and a corporation is that both have limited liability in common. Meaning, that both the members and the shareholders are generally protected from personal liability for the business’ actions. Further, both entities are considered separate entities and can accrue debts and liabilities on their own. Thus, members and shareholders are not typically held responsible for the debts and liabilities acquired by the LLC or corporation. Other business entities do not offer this type of protection for the owners and this can be a major selling point for forming one of these types of entities.
One last topic of conversation that must come up when discussing the right entity for a business owner to form is taxes. Everyone is required by law to pay taxes. It is important to direct any client to a financial advisor or accountant to help better lay out the tax benefits and consequences of forming each entity. However, an attorney, like a business lawyer Arlington, TX trusts, can provide a basic overview of the difference tax structures of an LLC and a corporation. An LLC, again, has flexibility in determining what type of tax structure they elect for the company. An LLC can make an election to be taxed like a partnership, so they receive what is known as flow-through taxation”, or the LLC can elect to be taxed similarly to a corporation. A corporation is taxed, typically, twice. The corporation is individually taxed on all profits the corporation gets during a tax year and the individual shareholders are also taxed on any profits they receive from the corporation. This double taxation can be a huge deterrent from forming a corporation. Again, it is very important to seek out financial guidance when it comes to making tax decisions for one’s business. An accountant or financial advisor may have different strategies and options for each entity that may not be known by an attorney. However, a brief overview can be helpful for a client making a decision as to what business entity they would like to form.
Fully understanding the differences and similarities between an LLC and a corporation is important. The decision to start a business is one that most people do not take lightly. That business owner needs to understand exactly what their options are. Some potential clients do not know they have options or do not fully understand the consequences of a decision they may have already made. It is your job as an attorney to ensure that all options and the consequences of any choices that are made are fully known to each and every client.
Thanks to our friends and contributors from Brandy Austin Law Firm, PLLC for their insight into LLC or INC.