I am often confronted with the question of why business owners should form an entity (that is an entity that is legally recognized as being separate and distinct from its owners such as limited liability companies (LLC), limited partnerships (LP) or corporations – as opposed to general partnerships or undocumented sole proprietorships – each legal entity is referred to as an “entity” for this post) for their business and whether it is worth the cost and hassle. In almost all cases it is clearly advisable to form an entity for a variety of reasons.
While having an entity, such as a limited liability company (LLC), is not a magic wand that can absolve the owner of such entity from liability from anything and everything (for instance the owner would still be liable for his own tortious acts when acting for the entity such as libel or slander) there is a great deal of protection that can be gained.
When structured correctly, and operated correctly, the business entity will be recognized as a legal entity separate and distinct from its owner(s) – even if there is only one owner. This means the business will have its own assets and liabilities distinct from the owner(s). Therefore, when the business entity has a liability it is a liability of the business entity and not the owner(s) of such entity absent special circumstances (such as a personal guarantee or a veil-piercing claim alleging the entity was not run sufficiently to allow liability protection). This can be very valuable if the business fails or an unexpected event occurs.
When you formally structure your business with an entity you are able to title assets in the name of that entity. While this consideration may be minor at first it leaves many doors open for the future. For instance it will be much easier to bring a partner into a business that is up and running with distinct books and records and with assets and contracts in its name than it would be if all items were legally in the name of the original owner.
Managing for Multiple Owners
In cases where more than one owner exists or multiple people may be participating in the success of the business it makes sense to have an entity – to document and divide the profits, losses and management control.
Having an entity separate from its owners formalizes the accounting relationship and allows for separate accounts and record keeping which is key to running and monitoring a business.
Image to Customers and Suppliers
Customers and suppliers get the message that you are committed to your business and plan to stick around when you form a business entity. Many people think that someone running a business in their own name doesn’t plan to stick around or many be testing the waters or not fully committed.
When you form a legal entity you get a possible layer of protection from judgment creditors. Such creditors may be able to seize assets of an unincorporated business but will have a harder time with an established legal entity. For instance, Section 18-703(e) of the Delaware Limited Liability Company Act provides that “No creditor of a member or of a member’s assignee shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.” Under Delaware law, a creditor can go after an owner’s interest in a limited liability company (LLC) but not after the assets of that limited liability company (LLC).
The separate legal entity can file for, and have, its own Tax ID number. This prevents the owner from having to give out their Social Security Number (or similar) to business counterparties. Also, business counterparties may not know who owns and controls the entity so some business anonymity can also be achieved.
Should I Do This Alone?
While it is tempting to just look at a form or copy and paste language what the documents that a friend used to form their company years ago bigger issues exist. Serious consideration should be given to the form or entity to be used, location of formation and long-term plans which might impact the formation process.
The tax, accounting and legal cost of making a bad decision at the time of formation or having an unfortunate provision in the governing documents of an newly formed legal entity that comes back to bite the company/owners later can easily be many times greater than the cost to hire someone to help early in the process.
About the Author
R. Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: firstname.lastname@example.org, (214) 418-0258 or www.mcbrideattorneys.com.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.