Corporation or LLC

One of the most frequent questions we receive from startup businesses is whether the new venture should be established as a corporation or limited liability company (“LLC”). There are significant differences between the two forms of business enterprises and these differences are significant in making the decision. We help match the strengths of your business plan with the best form of business structure. The following are some non-tax considerations in making the choice:

LLC’s can be controlled by its members or a manager. A manager may make decisions without the approval of any of the members.

A corporation is usually controlled by its board of directors, which then elects officers who manage the company under the control of the board of directors.

Generally for LLC’s, all members must approve a sale of the member’s interest particularly when a member participates in the management of the company. Approval of the other members is required in order for a buyer to become a member. The operating Agreement of the LLC usually controls the terms and conditions of a sale of a members interest.

Shareholders of a corporation usually have the right to sell or transfer their shares of stock unless that right is limited under buy-sell agreement between the shareholders.

In either choice, we strongly recommend that when there are multiple shareholders of corporation or multiple members of an LLC, there should be an agreement between the parties. With a corporation this is usually a shareholders’ agreement and in LLC’s this is referred to as an operating agreement.

Both corporations and LLC’s are created by filing either articles of incorporation or articles of organization with the Secretary of State. Very little information is required to be made public. However, with an LLC, there is significantly less information required to be filed with the Secretary of State. Usually terms governing the operation of the LLC’s business and the rights and authority of managers/members are set forth in the LLC’s operating agreement which is not filed with the Secretary of State.

In a corporation, a shareholders agreement does not have to be filed with the Secretary of State and will contain private information between the shareholders as to how the corporation is to be managed and governed.

Corporations are required to meet annually. There must be both a shareholders’ meeting and a board of directors meeting in which the actions and activities of the corporation of the last year are reviewed.

However, LLC’s, there is no requirement for an organizational meeting or regular meetings. An LLC is not required to have meetings to take management action nor are there any requirements mandated for notices of any meetings.

Changes in the tax laws over the past several years have made it very attractive to form a small corporation that makes the election to be treated as a Subchapter S corporation under the Internal Revenue Code. There are a number of important points that ownership must consider in dealing with this alternative form of ownership:

• Do new shareholders have to consent to the Subchapter S election?
• How is an election made?
• What are the tax aspects of the corporation making premium payments on life insurance policies that insure the lives of shareholders?
• Can a Limited Liability Company own Subchapter S stock?

Members of an LLC can limit the rights of any creditor to force a sale of their interest. A creditor of a LLC member is limited to what is referred to as a “charging order” which is a court order that entitles the members creditor to receive a distribution that the LLC would be making to the member. A creditor has no right to the member’s interest in an LLC and cannot assume the members voting and other management rights.

On the other hand, a shareholders interest may be subject to attachment by a creditor to force a shareholder to surrender his stock to the creditor.

The choice of whether to set up a corporation or LLC is a difficult choice and depends on a number of factors such as the type of financing, the goals of the investors, the type of business, and other factors which must be considered.

The experienced attorneys of Bellas & Wachowski Attorneys at Law have been helping its clients make these decisions for over 40 years and can assist you in guiding you in the formation of your business enterprise. Contact Senior Partner George Bellas (847.823.9030 Ext: 219 or george@bellas-wachowski.com) for more information.