Rules For Deciding What Legal Form Your Business Should Be

The following rules are what I consider when helping clients determine what legal form of business to create.  After over 22 years as a business lawyer, I realized long ago that there is no one-size-fits-all answer to this question.  I also realized there can be more than one correct answer.

I’m not going to get into the weeds here on the differences between corporations and S-corporations, LLC’s and LLP’s.  There’s plenty of that out there on the web.  Rather, I’m going to show my thought process and the counseling steps I use in helping my clients decide what form their business should take.

Four Rules on the Legal Form of a Business

•   Rule 1:  Assess your liability protection / personal asset protection.  This is the one that most clients worry about, and frankly it should be the least of their worries. In that regard, nothing beats good insurance.  Commercial General Liability insurance will cover personal injury and property damage arising out of the operations of the business.  The business form itself doesn’t matter.  As for breach of contract damages, which are not covered by CGL insurance, so long as one has properly formed one’s business, follows the formalities imposed on the business by law, and kept one’s personal financial assets separate, a person shouldn’t have much concern for personal liability for breach of contract.

• Rule 2:  What tax consequences will your business form give?  Each business structure has its own tax consequences.  That said, there are also rules in place that allow for pass-through taxation for small businesses of the various forms.  I don’t fly solo when it comes to taxes – I will work with my client’s accountant to counsel on the tax consequences of the various business forms.

Who Runs the Business?

• Rule 3:  Who really runs the business and how.  This is the most important consideration to most of my clients when deciding what legal form for the business.  This is what we call “corporate governance”.  In a same owner, same shareholder business it’s really not an issue – the owner makes all decisions.  After that, it all comes down to who gets to make what decision.

I’ll just use a basic, traditional corporation as an example.  The CEO, the Board of Directors, and the shareholders are all traditionally given authority to make various decisions through the By-Laws.  The CEO and other C-level execs. are given day-to-day authority to run the company and make decisions based on the business plan and long-term goals set by the BOD.  From hiring/firing, to advertising, to engaging with suppliers, to sales, the CEO makes sure the logistical aspects of the business take place.  However, his authority can be limited – such as getting BOD approval to enter into contracts totaling greater than a certain amount, say, $50,000; or writing/authorizing checks payable for more than a certain amount; or approving the sale of a new product not in the businesses core plan.

At that point, the BOD exercises its authority to approve/disapprove the contract or expenditure or business expansion.  In addition, the BOD will prepare long-range plans for the businesses growth and success, to be implemented by the CEO; set C-level compensation and bonuses; and approve dividends.  Finally, the shareholders are usually given authority to (a) choose BOD members; (b) approve/disapprove the complete sale or liquidation of the business.  Of course, every one of these decisions can be allocated differently depending on who is forming the business, their purpose in doing so, and who they want making the decisions.

One Last Rule

• Rule 4: Do you have or need an investor strategy?  Especially in a business that plans on using angel or venture capital to grow, a simple C-corporation works best for tax reasons that benefit the investors, and governance purposes (they’re easy to run from a technical standpoint). Legal form matters.

As you can see, “what form should my business take” is not an easily answered question.

Conclusion on Legal Form of the Business

I’ve practiced business law of all sorts for over 20 years.  I’m familiar with the various business entities, what form of business a client should choose, the laws and statutes governing them, and I’ve probably done what you want to do with your business.

Contact me if you have any questions on business transactions. In western North Carolina, Asheville, Waynesville, Hendersonville at (312) 671-6453.

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Be sure to check out my other blog posts HERE.  Be sure to listen to my podcasts with Matt Mittan at BizRadio.US