As a full service law firm, Scura, Wigfield, Heyer, Stevens & Cammarota LLP provides legal services and advice to both established corporate entities and start-up companies. One of the most common questions that individuals looking to launch a start-up company ask is: What type of business entity should I form? Our firm has extensive experience with Limited Liability Companies, C-Corporations, S-Corporations, Partnerships, and Sole Proprietorships. Notwithstanding, the most common types of business entities are LLCs and Corporate Entitles, C-type and S-type. This blog will focus on the legal issues related to the two most common business entities. Lastly, please speak with a tax professional prior to forming a corporate entity to determine which tax classification is best for your business purposes.
Benefits of a Limited Liability Corporation
In recent years, LLCs have become the entity of choice for structuring most business operations because of the flexibility and tax benefits it provides. An LLC combines the liability protection of a corporation with the tax benefits of a pass-through entity (S-Type). An LLC with two or more owners generally will be treated as a partnership for federal tax purposes, however an LLC entity may choose another tax classification. Consequently, if members prefer corporate tax treatment (C-Type), they can make an election on IRS Form 8832 to effectuate the change.
LLCs are also popular because of their flexible management options. For example, LLCs are not responsible for annual shareholder meetings, do not require approval from shareholders on certain legal issues pursuant to corporate bylaws and articles of incorporation, do not require corporate resolutions, and there are no requirements for corporate minutes. This gives the owners and managers of an LLC more flexibility to make swift or timely decisions. It also significantly reduces the time spent on administration rather than strategic planning. Unlike corporate entities, the basic premise of statutes governing LLCs is that such entities will be governed internally by way of contractual agreements of the members. Therefore, it is very important that an LLC’s operating agreement is clear and comprises of all foreseeable actions of the company.
Benefits of a Corporation
Corporations on the other hand have a set management structure whereby directors oversee the majority of business decisions and officers are responsible for the day-to-day operations. Corporations are also required to have annual meetings, provide notice to shareholders, keep minutes, and pass corporate resolutions. Again, administration can be costly and limit the management possibilities of the company.
Corporations are often the preferred choice of developing businesses. Corporations can sell stock in the company therefore raising capital. If a corporation plans to go public or sell stock to a large group of people, the corporate stock might be easier to sell than membership interests in an LLC. Owners can hold different types of stock interests (including preferred and common stock), which allows for different levels of dividends.
With regards to liabilities, unlike the well-established duties of care and loyalty owed by a director to a corporation and its shareholders, the fiduciary obligation owed by those managing an LLC are unclear in many states, including New Jersey. Consequently, if legal issues arise, the more defined duties of care and loyalty in a corporate entity makes it much easier to pierce the corporate veil and hold shareholders/directors/and officers liable. Notwithstanding, LLC members and corporate shareholders are protected in the same manner from lawsuits.
The most notable liability distinction occurs when an individual shareholder or LLC member is sued. For example, Owner A owns 100 shares in Big Money Innovations, Inc. If Owner A is sued and found liable, the Court could force Owner A to sell his 100 shares in Big Money Innovations, Inc. It is also possible that if Owner A is the majority shareholder the plaintiff could step into the shoes of Owner A and force the sale of corporate assets.
If Owner A owns 51% of Mega Bucks, LLC then the most a plaintiff could receive is a charging order. Essentially, a plaintiff could only receive the financial rights distributed to Owner A until the charging order is satisfied. Upon satisfaction, Owner A will begin receiving funds and any other financial interest previously held. Owner A will also maintain its management rights. Consequently, the plaintiff will only obtain financial rights and cannot participate in management of the LLC. This is a significant advantage over a corporate entity.
As provided in the New Jersey LLC statutes, no member or manager of a limited liability company shall be obligated personally for the debt, obligation or liability of the limited liability company. Similarly in New Jersey, a shareholder of a corporation is not personally liable for the acts of the corporation, except that a shareholder may become personally liable by reason of his or her own acts or conduct. Moreover, officers and directors of a corporation are generally not liable for debts of the corporation merely because they are officers or directors or are engaged in active management. However, members, managers, directors, and officers of both LLCs and corporate entities may be personally liable for a corporate debt through willful misconduct of the entity. This willful misconduct may lead to entities and individuals piercing the corporate veil. Under New Jersey law, personal liability will only be imposed if it is demonstrated that the officer or director disregarded the corporate form and utilized the corporation as a vehicle for committing equitable or legal fraud. An individual may be liable for corporate obligations if he was using the corporation as his alter ego and abusing the corporate form in order to advance his personal interests.
Some examples of piecing the corporate veil include, gross undercapitalization, failure to observe corporate formalities, non-payment of dividends, absence of corporate records, knowledge of corporate insolvency, siphoning of funds of the corporation by the dominate stockholder, non-function of other officers or directors, and the fact that the corporation is merely a facade for the operation of the dominant stockholder or stockholders.
Prior to determining which corporate entity to form, it is extremely important to speak with a tax professional to discuss which type of entity best servers your monetary goals. This blog only relates to legal issues, not tax benefits of each type of corporate structure.
If you’re thinking about forming a start-up coming, or if you’re already an established corporate entity, please call our firm to discuss legal services and ensuring that your company is prepared for long term success.