Business Law

What’s the Best Course of Action to Protect Yourself in Business?

The Law Office of Frederick S. Schwartz has over two decades of experience assisting individual and small business owners with their legal needs. This experience includes Limited Liability Company (LLC) and Corporation formation; reviewing and drafting agreements such as contracts, non-disclosure agreements, settlement and releases, independent contractor agreements, and other related matters. Frederick S. Schwartz has substantial litigation, mediation, arbitration, and trial experience representing both Plaintiffs and Defendants in business disputes.

Prior to becoming an attorney, Frederick Schwartz lived an worked in South Korea and elsewhere in Asia as a buying agent. This unique international business experience and the insight it provided, has been a valuable tool and asset to his business clients. It is the Law Office of Frederick S. Schwartz’s objective to advance its clients’ interests and get the best results while minimizing the cost and burden associated with litigation.

Choosing Wisely: Which Legal Structure Best Suits Your Business Needs

Limited Liability Company  vs. Corporation

It is perhaps the first legal dilemma of every entrepreneur to decide which particular legal structure to choose when first forming his or her new business entity. Deciding between incorporating and forming an LLC often is as confusing as it is crucial for your future business development. There are a few key factors one must consider when deciding; what tax benefits can be gained through either? Which one is easier to set-up? What is the difference in cost? What activities is the business going to undertake? What incentives can be provided to the employees?

To answer these questions you should first assess the benefits of a Limited Liability Company. Forming your business as an LLC can be relatively easier than incorporating. Moreover, it is also the more cost-effective choice. Maintaining an LLC is less obstructed by the fact that LLC’s legislative design does not require it to hold and record shareholder meetings like a corporation. It also does not require by-laws.  Instead,  a simple operating agreement is enough to keep an LLC properly maintained. However an LLC owner is obligated to pay a self-employment tax on income generated by the LLC, which can become a substantial chunk of earnings once the business begins to grow.

It is also imperative that the owner runs the LLC as an entity instead of a shell, carefully separating its activities from their personal ones in order to retain their legal advantages and protections offered by the LLC. One of the ways to do this is to set-up a separate checking account for the LLC. There have been past-cases (Stone v. Frederick Hobby Associates II, LLC 2001) where owners did not make a clear distinction between their personal and business endeavors and subsequently lost the protections offered by their LLC.

The legal protections offered by a limited liability company come mainly in the form of protection from creditors. In California, a creditor may be able to gain ownership of the shares you own in a corporation in cases of delinquency. A creditor may gain majority of shares within your corporation in this way and essentially overtake control of the corporation. However this is not possible with an LLC, where no shares are issued the only option available to the creditor is to gain a charging order from the court. A charging order enables a creditor to collect money when an LLC distributes its earnings to a certain member, although the LLC may choose not to distribute earnings in such a case.

Another legal protection of the LLC is its limited liability, which means that normally (and there are exceptions to this) an owner of an LLC is not liable for debts incurred or actions of its employees, therefore an LLC limits the creditors to its own assets thus only those assets and investments that were made into the LLC, not those owned by the owner. The main exception in this case is if an owner personally guarantees payments or promises to pay back debts of the LLC.

Durability is also an important aspect to consider when establishing an LLC, while recent legislative changes enable an LLC to operate indefinitely in most states, if a partner or one of the founders within an LLC leaves the LLC for any reason, including death, then the LLC is considered dissolved, and in order to continue its operations the remaining partners must reform a new LLC. This of course can be avoided with the inclusion of a professionally written operating agreement which should clearly outline agreed upon options in case of such an event. One of the most effective options is to include a buy-out or transfer mechanism in favor of the company. Yet another reason why a well thought out operating agreement is absolutely crucial to have, and often requires contribution from an experienced attorney.

Incorporating also has its pros and cons, these being the bureaucracy that comes with setting up an S corporation or a C corporation respectively. S corporations have instituted limits on passive activities such as real estate investment and it is also more costly to set-up and maintain a corporation in comparison to an LLC, however doing so has its rewards. An S corporation has significant tax benefits when it comes to excess profits. It also pays all employees (including the owner) a ‘realistic’ wage depending on profit that should adhere to industry standard, which deducts payroll expenses such as federal taxes and FICA. Any remaining profits can be distributed as dividends and taxed at a lower rate than income.

An S or a C corporation is also able to provide incentives in the form of shares in its own enterprise for the employees; this option is not available for an LLC which only holds units and not shares. S Corporations are limited to having one-hundred share owners or less however. Moreover, from a legal perspective a corporation is able to raise capital through the sale of its stock. It is also important to note that a corporation is able to establish its own line of credit and build a separate credit history independent of its owner’s. A corporation also enjoys limited liability and protection of personal assets of the individuals involved within the corporation. This means if an investor purchases $500 of stock he is not liable for more than $500 within the company and is not responsible for any further debts accrued.

Limited liability can be maintained by properly structuring and running a corporation, mainly adhering to having regular board meetings and outlining a comprehensive company policy. Unlike an LLC the operations of a corporation are not affected by the transfer of shares, or death of a shareholder. While corporations enjoy relatively greater legal independence from its owners, they require considerably more maintenance and this is the biggest disadvantage of creating a corporation. Be it in the form of obtaining a federal tax ID number, setting up its own bank account or consulting with a tax professional per annum.

Having covered the most important differences between the two entities there is still one important thing to consider. While this article is designed to help you understand the basic differences between an LLC and Corporations, it is nearly impossible to cover every variable of tax and business law that could apply to your business. Furthermore legal paperwork such as internal operating agreements or company policies can involve complex procedures which may prove to be difficult to properly outline without a legal professional’s help. Therefore it is always advisable that you contact a professional for further advice when assessing what type of structure is best suited for your business.