It's all about the business.
There are many different entity formation options available for small business clients to choose from. Our lawyers guide our clients through each option to best fit their needs based upon the goals of the entrepreneurs, the owners’ tax situations, and the exit strategy. We help our clients understand the difference between entity requirements for state law issues as well as their options for Federal taxation to meet both short and long term goals. We have helped entrepreneur start-ups with the following entities:
- LLC (Limited Liability Company)
- Small Business Corporation (S-Corporation)
- Professional Limited Liability Company
Our services range from helping new clients through the initial start-up procedure, through capitalization and on-going business transactions, all the way through wind up and dissolution of a business.
Generally, the first consideration in setting up a business is the choice of entity in which to conduct the business. To that end, there are tax and nontax considerations. This item presents an overview of some of the tax points that should be kept in mind when choosing an entity. It focuses primarily on the taxation of the partnership and corporate forms of doing business, the pros and cons of each, as well as the distinctions between C corporations and S corporations.
To set the stage, the item sets forth some nontax considerations for partnerships, corporations, and limited liability companies (LLCs). For tax purposes, an LLC may afford more flexibility because, through a simple election, it can be taxed either as a partnership, a C corporation, or an S corporation. Next, this item focuses on tax considerations, contrasting the income taxation of partnerships, C corporations, and S corporations, and exploring issues such as compensatory options and attracting investors. Finally, this item examines a few critical post-formation considerations, focusing on the implications of foreign operations and certain issues related to separating business lines.
Partnership: A partnership is a legal entity for a business entered into by two or more persons. There are two types of partnerships: general or limited. In a general partnership, all the partners are personally liable for partnership debts. In a limited partnership, however, at least one partner must be designated as the general partner, and that general partner has unlimited personal liability for partnership debts. The limited partners, on the other hand, are liable only to the extent of their investment in the company. However, a limited partner might lose his or her "limited" status and thus be personally liable for partnership debts if he or she is viewed as playing a role in management, i.e., acting as something other than a purely passive investor.
Corporation: Corporations are legal entities independent from their owners and provide some protection from personal liability. Thus, a shareholder's risk of loss is limited to his or her direct investment in the corporation. However, to sustain that liability shield, certain legal formalities must be observed, e.g., a corporate charter, bylaws, and a board of directors, as well as compliance with regulatory reporting requirements. Compliance with these formalities often comes with significant legal costs, which may be daunting for a startup company.
Additionally, shareholder and stock restrictions under Sec. 1361 come into play when comparing an S corporation to a C corporation. C corporations allow for an unlimited number of shareholders, with no restrictions on the type of ownership, whereas S corporations have a limit of 100 shareholders, all of which must be either U.S. citizens or permanent residents, certain trusts, bankruptcy estates, other estates, and certain tax-exempt organizations, not corporations (including LLCs) or partnerships. Although a C corporation does not restrict stock issuance, an S corporation can have only one class of stock.
LLC: LLCs have become increasingly common, particularly in the startup realm. In general, it is far easier and less expensive to set up an LLC than it is to set up a corporation. An LLC only requires an operating agreement outlining the expected duties of managers and the general governance of the company, thereby avoiding some of the costlier corporate formalities mentioned above.
Corporate rules are in place for everybody's protection.
Corporate governance is an important, and oftentimes overlooked, part of setting up your new business. Good corporate governance documents, such as operating agreements, buy/sell agreements, and corporate bylaws ensure that a business runs smoothly and efficiently. Perhaps more importantly, detailed and thorough governance documents can keep matters on track and in-line if relations within a business start to deteriorate. It's times like this that inadequate governance documents can quickly lead to litigation and even an eventual end to the business if matters cannot be settled.
What is 'Corporate Governance'?
Corporate governance is the system of rules, practices and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Since corporate governance also provides the framework for attaining a company's objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.
!--break--Governance refers specifically to the set of rules, controls, policies and resolutions put in place to dictate corporate behavior. Proxy advisors and shareholders are important stakeholders who indirectly affect governance, but these are not examples of governance itself. The board of directors is pivotal in governance, and it can have major ramifications for equity valuation.
The Board of Directors
The board of directors is the primary direct stakeholder influencing corporate governance. Directors are elected by shareholders or appointed by other board members, and they represent shareholders of the company. The board is tasked with making important decisions, such as corporate officer appointments, executive compensation and dividend policy. In some instances, board obligations stretch beyond financial optimization, when shareholder resolutions call for certain social or environmental concerns to be prioritized.
Boards are often comprised of inside and independent members. Insiders are major shareholders, founders and executives. Independent directors do not share the ties of the insiders, but they are chosen because of their experience managing or directing other large companies. Independents are considered helpful for governance, because they dilute the concentration of power and help align shareholder interest with those of the insiders.
Good and Bad Governance
Bad corporate governance can cast doubt on a company's reliability, integrity or obligation to shareholders. Tolerance or support of illegal activities can create scandals like the one that rocked Volkswagen AG in 2015. Companies that do not cooperate sufficiently with auditors or do not select auditors with the appropriate scale can publish spurious or noncompliant financial results. Bad executive compensation packages fail to create optimal incentive for corporate officers. Poorly structured boards make it too difficult for shareholders to oust ineffective incumbents. Corporate governance became a pressing issue following the 2002 introduction of the Sarbanes-Oxley Act in the United States, which was ushered in to restore public confidence in companies and markets after accounting fraud bankrupted high-profile companies such as Enron and WorldCom.
Good corporate governance creates a transparent set of rules and controls in which shareholders, directors and officers have aligned incentives. Most companies strive to have a high level of corporate governance. For many shareholders, it is not enough for a company to merely be profitable; it also needs to demonstrate good corporate citizenship through environmental awareness, ethical behavior and sound corporate governance practices.
At Gravis Law, you will receive governance documents that are both proven and tailored specifically to your individual business situation and long term goals.