Most new business owners, after investigating an idea and developing a business plan, are faced with deciding what kind of legal entity they should form their company under. Of the four types (sole proprietorship, partnership, corporation, or limited liability company), corporations and limited liability companies (LCCs) are often preferred. In a recent Huffington Post article, these two types of entities are described as “easily the two most popular business structures.” But which one should an entrepreneur choose? That’s what the article aims to help you determine.
Author Deborah Sweeney points out various pros and cons for each entity, which are condensed below:
- Limits owners’ personal liability for debts
- Easier to run (less requirements and flexible structure)
- Owners all have the same amount of decision-making power as other owners [We address the validity of this below]
- Owners have decision-making power according to ownership stake
- More difficult to run (strict requirements on decisions and reporting)
Sweeney’s breakdown is overly-simplified. Although she correctly asserts that corporations require greater formalities than LLCs, and are thus “easier to run”, she makes other mistakes. Both LLC and corporate owners have limited liability. This is primarily why both LCCs and corporations are the most popular business structures. Further, corporate owners are usually not allowed to participate in the management of the company; they only do so through directors.
She also gets some things wrong.
Most importantly, she incorrectly states that LLC owners all have the same amount of decision-making power. This is not entirely correct. Under many state laws, including Minnesota laws, the voting power of members when voting on governors (the LLC’s version of directors for a company’s board) is “cumulative”, which means each member has the number of votes allotted to them according to their ownership (or, sometimes called membership) stake in the LLC. This is often limited in the articles of incorporation for an LLC, which is the form required for establishing an LLC in most states.
For other decisions, voting is controlled by provisions in the member control agreement, which can stipulate that members have equal voting power or voting power according to their ownership. Often, these agreements can be very complex, depending on the preferences of the founders of the company as well as those who are financing it.
At the end of Sweeney’s article, she asserts that entrepreneurs are happiest when they choose the right kind of legal entity for their business needs. We couldn’t agree more, but this requires the entrepreneur to understand more of the pros and cons and work with an experienced legal professional to make the right decision. Consider contacting Vlodaver Law Offices, LLC to get expert advice on establishing a new business.