You may be asking “Which entity should I choose”?, “What is Inc.”?, “What does Co. mean?”, “What is LLC”? or “Ltd vs. LLC”? Before you incorporate, you need to choose which type of entity is right for you. This slows down many entrepreneurs in the start-up process because this is not taught in elementary school, college, business school or even most law schools. Entrepreneurs are
often stuck searching the web, reading books, or asking questions of incorporation services in an area very unfamiliar to most people; however, to business attorneys and incorporation services, this is our lifeblood. We live and breathe this – and enjoy it. Yet we are patient to make sure that the smart people, like you, who are not familiar with the choices available and differences can make an informed decision to help their business succeed.
Businesses are formed at the state level, and state law differs with regard to these entities. The state law defines the different forms of businesses available. State’s also require corporate endings that are required for certain choices of entities.
Limited Liability Companies (LLCs)
Generally speaking, the best form of entity for most small businesses and property owners is the Limited Liability Company (LLC). The LLC is a relatively recent creation in the grand scheme. Although first available in the late 1970s, it was decades later that most states adopted them. The LLC overtook corporations as the most popular form of business entity in the mid-2000s, in large part because of the unparalleled versatility and protection offered by the LLC. Many consider the LLC to be simply light-years ahead of all other forms of business entities.
An LLC is owned by members and operated by either third-party managers or the members themselves. It is a very flexible form of business which accounts for why almost 75% of new businesses formed today are LLCs. The LLC Operating Agreement is the governing document to allow you to arrange the LLC’s affairs as the members choose.
Other Entities to Know
The following list contains examples of endings which all apply to the same “general corporations” having shareholders, directors and officers: Inc., Co., Corp., and Ltd. are the same thing (abbreviations of Incorporated, Company, Corporation, Limited). Incidentally, some states allow “Ltd.” to be used for an LLC or Limited Partnership.
You may have heard of a close-corporation. That is also a form of Corporation designed to cut through some of the corporate separation between the stockholders and officers, as it allows for the elimination of the board of directors. It also has a limited number of stockholders. Historically this was only to be used with family businesses. It is old-fashioned, since most family businesses today would form an LLC if they are not comfortable with the rigid corporate hierarchy.
You may have heard of the S-corp and C-corp, but they are not different forms of corporations at the state level. Instead, those are just tax election designations made with the IRS and Division of Revenue after the corporation is formed. Rather than filing an S-corp or a C-corp with the state, the corresponding form for either simply needs to be submitted to the IRS to chance the tax nature of the company.
You may have also heard of the B-corp, which is a B-Lab certification that can be applied for certain entities that provide larger social benefits, other than maximizing profits. Similarly, a “Public Benefits Corporation” is a corporation that can provide stated public benefits. This is really nothing but a regular for-profit corporation, where the corporation is allowed to give away or benefit other causes and concerns consistent with its Certificate of Incorporation without risk of stockholder lawsuits for waste of corporate assets.
Additionally, there is a not-for-profit corporation, which is a type of non-stock corporation. Usually these are organized for public charities or private foundations. They do not have stock and instead are run by its members through a board of directors. If a non-stock corporation applies for tax exemption and it receives a tax determination letter, it can accept donations tax deductible to its donors as an IRS-approved 501(c)(3) corporation.
You may also have heard of Statutory Trusts, formerly known as “Business Trusts.” These are corporate entities which function much like traditional trusts with beneficiaries and trustees. These are flexible and governed by a Trust Agreement. They are not recommended for most business purposes because they require a Delaware headquartered Trustee.
The other types of business entities are variations on partnerships, such as:
- LLP (Limited Liability Partnership) – usually only for professionals like lawyers and doctors – Weakness: does not protect you from your own negligence,
- LP (Limited Partnership) – requires both active managers called general partners and passive investors called limited partners – Weakness: does not protect the general partner from personal liability,
- LLLP (Limited Liability Limited Partnership) – same as LP, but it offers general partner personal liability protection – Weakness: unusual form of entity that is similar to an LLC, but unnecessarily complex,
- GP (General Partnership) – no personal liability protection – partners are each jointly and separately responsible for all of their partners actions,
- Sole Proprietorship (or DBA– doing business as) – no liability protection whatsoever, inexpensive to form, but very risky.
These above five business types are not right for most businesses. They are clunky for most small businesses or may not offer as much protection or any protection for owners against business creditors.
The Series LLC
One variation of the LLC is the Series LLC. That is one LLC which designate certain classes of assets and members to an unlimited number of internal protected “series” where if operated properly the liabilities of one series do not attach to the assets of the others. In essence, one LLC can be the parent company for many individual LLCs under the same umbrella. This allows for much internal assets segregation, without having to endure additional state filings.
Aside from choosing the entity, you also need to choose the state of incorporation. Since the law where your business is located may not be favorable to your company, such as California, Pennsylvania and New York, you should look to the “gold standard” state for incorporation, which is Delaware. Choosing to incorporate in Delaware may help resolve problems with ownership disputes and other issues down the road, because Delaware is known for having the best corporate laws and courts to resolve corporate disputes.