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Why incorporate a business entity?

Limited Liability of Shareholders
The hallmark of a business Corporation is the limited liability afforded to its owners, the shareholders. This is because a Corporation is regarded as having a separate legal existence from its stockholders - that is, it is capable of making contracts, owning property, suing/being sued, and the like. Thus, under normal circumstances, a Corporation, as a separate legal entity, and not its stockholders, is responsible for the Corporation’s own corporate debts and obligations. By way of contrast, each of the partners of a Partnership is subject to unlimited personal liability with respect to the debts of the Partnership. In order to maintain the shield of limited shareholder liability, a Corporation must, among other things, observe basic formalities such as maintaining corporate records (e.g., minute book, conducting annual shareholder meetings/actions by consent in lieu of such meetings, etc.). Our Corporate Kit and Compliance Services can help you meet these requirements.

Perpetual Existence
As a separate legal entity, a Corporation continues notwithstanding the death or incapacity of any of its shareholders or the transfer of any of its shares.

Centralized Management
The management and control of a Corporation’s affairs is centralized in a board of directors and officers acting under the board’s authority.

Ownership and the Raising of Capital
Subject to compliance with applicable federal and State securities laws, and absent any relevant restrictions in corporate organizing documents or stockholder agreements, (i) a Corporation’s outstanding stock can be transferred fairly easily from one holder to another and (ii) a Corporation can raise capital more easily than other types of business organization through the sale of stock.

What is a Limited Liability Company?

Quasi-Corporation / Quasi-Partnership
A Limited Liability Company (LLC) is an unincorporated association organized under State Law. It is a hybrid entity in that it combines certain attributes of Corporations (e.g., limited owner liability) with certain attributes of Partnerships (e.g., tax treatment). The owners of an LLC are generally called members. Some States require a minimum of two members, but others, such as Delaware, allow one-member LLCs.

What are the relative advantages/disadvantages of Corporations and LLCs?

General
As discussed above, both Corporations and Limited Liability Companies afford their owners (stockholders in the case of Corporations; members in the case of LLCs) limited liability protection, i.e., the owners of the relevant entity are typically not personally responsible for the debts and liabilities of its business.

Taxation
The primary difference between Corporations and LLCs is that Corporations are separate tax-paying entities while LLCs are normally taxed as Partnerships. This means that a traditional Corporation (C Corporation) is subject to a corporate income tax and its stockholders are subject to an additional tax when they receive dividends (Double Taxation). In an LLC, there is no separate tax at the company level and the members are taxed directly on the company’s profits (Pass-through Taxation). A C Corporation can avoid Double Taxation by electing Pass-through Taxation, i.e., S Corporation status, and thereby attaining tax treatment similar to that of an LLC. It should be noted, however, that S Corporations may not have more than 75 stockholders, and none of these may be a Corporation or a non-U.S. resident. Furthermore, a Corporation’s S Corporation status will lapse (and cause the Corporation to revert to C Corporation status) immediately upon such Corporation’s failure to comply with any of these or other restrictions.

Formalities
A Corporation is required to follow certain formalities. For example, a Corporation must hold an annual meeting of shareholders and meeting minutes must be kept with the Corporation’s records. LLCs are not required to hold such meetings; however, it is a good idea to document the company’s major decisions and hold regular meetings of members.

Management
Ordinarily, Corporations must have directors who are responsible for making policy decisions and officers (e.g., President, Treasurer, and Secretary) who are responsible for day-to-day operations. LLCs may be configured more flexibly. By way of example, an LLC may have one or more managers running the company or the members may manage the LLC directly; no officers or directors are required.

Going Public
If your business is ever likely to go public, it will have to be as a Corporation. It should be noted that an LLC should be able to convert to a Corporation prior to going public without major tax consequences.

Selecting an appropriate State to incorporate (or form an LLC)

Once the decision is made to incorporate a business, the business owner must select an appropriate State for Incorporation. It is not necessary that the business be incorporated in the State in which it is operating; in fact, you can choose from among any of the 50 States or the District of Columbia. In deciding where to incorporate, some of the factors you may wish to consider include:
  • The location of your physical facilities;
  • The cost of incorporating in the State in which the business is operating versus the cost of incorporating in one State and qualifying to do business as a foreign Corporation in the State of operation (this decision often boils down to a comparison of such costs with respect to the State of operations and such business friendly jurisdictions as Delaware, Oregon, and Arkansas);
  • The advantages and disadvantages of the business laws and tax structure of each of the States under consideration.
A Corporation that is organized in one State and qualifies to do business in another State is subject to applicable annual franchise taxes and fees assessed by each State. Thus, the actual advantage of incorporating in a State with very low or no corporate income tax is not as great as it might first appear, particularly if your business must still qualify to do business in the State in which it is operating.