LLC or Corporation? How to Choose When Forming Your Business? (Part 1)
There are many different types of entities entrepreneurs and start ups can form to manage their business. Each entity has its own pros and cons. There are limited liability companies (“LLCs”), a relatively new invention (LLCs, as an option, did not exist until the late 1970s). There are limited liability partnerships (“LLPs”) or in some states, limited partnerships (“LPs”). Then there are your good old-fashioned corporations (“Inc.”). Other states still have other formats or variations on the above, but these are some of the main entity types in existence today (which are common in most states). This blog post will focus on a few of the basic differences between two of the more common entities selected, LLCs and corporations, in North Carolina. Because of length, Part 1 will focus on corporations, while Part 2 will focus on LLCs.
Corporations
Corporations can have one or more shareholders. A corporation owned by shareholders and managed by directors and officers. The shareholders elect the directors and the directors elect the officers. A corporation must have at least one director and may have a number of officers. Typically, a corporation will have, at the very least, a President and a Secretary. A corporation could also have a Vice President, Treasurer and any number of assistant officers. A corporation is a separate legal entity and can own real and personal property, incur debt, enter into contracts, etc.
Taxation: A corporation can either be taxed as a separate entity (a “C-Corp”) or as a partnership/sole proprietorship (an “S-Corp”). All corporations begin as a C-Corp, and the corporation can make an S election at specific times by filing the appropriate form with the IRS.
Formation: In order to form a corporation in North Carolina, Articles of Incorporation must be filed with the Secretary of State, along with a fee of $125. This is the bare minimum needed in order to form a corporation.
Management: While a corporation can be formed with just a simple fee and the Articles of Incorporation, a corporation should also have bylaws which direct the management of the corporation. Bylaws provide direction as to the number of directors and officers, the duties of directors and officers, dates and times for annual meetings of shareholders and directors, limitations on director/officer liability, etc. If a corporation has more than one shareholder, the shareholders of the corporation should consider a shareholder agreement. Shareholder agreements lay out provisions which provide direction as to what occurs when a shareholder dies, wants to sell his/her shares, whether shareholders are entitled to financial statements, etc. Having these documents in place and agreed upon, early in the corporation’s existence, is paramount to curbing issues down the road.
Shareholder Liability: Typically, shareholders are not personally liable for any of the debts of the corporation (except for the value of their shares and therefore, interest in the corporation). However, in situations where corporate formalities were not observed (shares were not issued, meetings not held and documented, etc.), courts or the IRS may “pierce the corporate veil” and hold shareholders personally liable for the corporation’s debts. Obviously, a very good reason to maintain corporate records.
Upkeep: On an annual basis, a corporation’s directors and shareholders (each separately) must have an annual meeting, where new directors and officers are elected, and other business is conducted. These meetings are documented and all documentation is maintained in corporate books. Additionally, the corporation must file an Annual Report with the Secretary of State (failure to do so can cause administrative dissolution of the corporation), along with a $25 fee.
Additionally, if the corporation’s director(s) wish to make a large transaction, perhaps take out a large loan in the name of the corporation, and such an action is not contemplated or explicitly allowed in the bylaws, the shareholders will have to explicitly authorize such an action by written consent (or in person vote).
Look for Part 2 on LLCs next week.
