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Here’s a hypothetical. You’ve operated your business for three years. During those three years you contracted with a variety of vendors and clients as to provide your goods or service. You enjoy your work, in fact you love it, it is your passion. Just this morning however, you were served with a summons and complaint by one of your clients claiming your product or service was faulty and caused damages to their business totaling more than $100,000. Outrageous? Perhaps. Unusual? No. If you’re found liable, where will that money come from? The answer depends on the type of business structure you are operating under.
If you have been operating as a sole proprietor your risks are extensive. As a sole proprietor you are personally liable for business debts and liabilities. This means the plaintiff can pursue not only your business and all its assets but your personal assets as well, including your home. The good news is there is a relatively easy and simple way to protect your most important assets.
If you organize as either a Limited Liability Company (LLC) or a Corporation (C or S) you immediately form a protective wall around your personal assets. This means your home, car, boat, etc. are protected from business creditors. To decide which form is right for you and your company there are many factors to consider, including: tax treatment, potential investors, and your preferred management structure.
One of the first considerations for many business owners is tax treatment. C-Corporations are subject to double taxation; first the company pays tax on money as it comes into the corporation and the shareholders pay tax again when they receive their dividends. S- Corporations and LLCs on the other hand, have what is known as pass-through taxation; there is no company-level tax, instead tax is paid only once when the shareholders or owners receive the money. (Note that due to the passage of Measure 67, S- Corporations and LLCs will now incur a company-level minimum tax of $150 that did not exist before.) In addition, benefits such as cafeteria plans, life insurance, and disability insurance receive different tax treatment depending on the business structure. These are just a few of the tax differences between a C-Corporation, S-Corporation, and an LLC.
A second consideration involves whether and what type of investors your company plans to pursue. Some investors prefer to receive stock in exchange for their investment. Stock however, is only available from corporations and not LLCs. Furthermore, the investor may require preferred stock in place of common stock. Because S-Corporations are restricted to a single class of stock a C-Corporation may be more appropriate. Thus, your financial plans may dictate the type of business structure that is best for your company.
Finally, you want to consider the management structure. S and C-Corporations retain the traditional structure of shareholders, a board of directors, and officers such as president, secretary, and treasurer. Each title has its own duties and powers. An LLC on the other hand, will be either member-managed or manager-managed. This allows you flexibility for any number of governing structures to run you business. Thus, consider your vision for management in considering the type of structure you prefer.
Once you’ve weighed your options and acted on your choice, you can focus on running your business and relax knowing your home is protected from business creditors.
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