R. Shawn McBride recently spoke with Angela Langlotz, a fellow attorney, http://trademarkdoctor.net/ about some of the differences between an LLC and Corporations. You can find the full interview here:
https://www.facebook.com/rshawnmcbridepublic/videos/1450372261661342/?pnref=story
R. Shawn McBride: Hey everyone, Shawn McBride here. I’m with my friend Angela Langlotz and we’re going to be talking about LLCs versus corporations. This didn’t just come out of thin air – I was asking people recently what kind of issues they are seeing in their business. This came up so I’ve got a fellow attorney here to get us kind of familiarized with the issues and we want to make it understandable to you, so for those of you that are tuning in live, you can ask questions as we go. Those of you that watch us on a replay, just go ahead and send those questions so that we can take a look through them and we’ll maybe tailor some additional content for you. So, Angela you want to take a second and introduce yourself?
Angela: Sure, thanks Shawn. I’m Angela Langlotz. I practice trademark law right now, but I’ve spent many years doing estate planning and business planning for closely held family businesses. So let’s have some banter about LLCs and S corps and, you know, any other alphabet soup things that we can think about to discuss. Why not?
R. Shawn McBride: Yeah, and a lot of people think that there is something mythical about LLC versus the corporation and which one works and all that, but really there are slight differences.
But the first step is, do you need an entity, right? So do you want to be a separate legal entity – in many cases it makes sense, unless you’re a very small operation. If it’s just you and your business … I was talking to a business owner earlier today … may not make sense in that case, you know, but if you’re getting to that size that you have employees, or your operations that don’t involve you. You have something passive going on, you’re holding a piece of asset this isn’t being used, or something like that, then maybe yes, you are looking at an entities. So you need to look at your business first and figure if you want an entity. Then it becomes a little more of a nuance discussion. Which one works for you, which ones meets your needs.
Angela: Right, yeah. The thing I like about LLCs is well they have corporate requirements that are a little bit more relaxed than corporate rules so things about meetings, and corporate formalities and all of that, yeah you should keep everything separate just like you do with a corporation, but it’s a little more relaxed as far as corporate formalities and we can tax an LLC anyway we want. So we can tax an LLC and tax it like an S corporation . . . well what we do is tax it like a corporation and then we make the S election. We can tax is like a partnership, so it has a lot of flexibility as far as how we operate the business and what kind of tax structure we can have. So, I really, really like LLCs a lot and that’s how I have all my personal entities set up. They are all LLCs.
R. Shawn McBride: I think that most people have seen that the LLC has become more popular than the corporation. If you look at most State filing records, the number of LLCs in most States greatly exceeds the number of corporations. People are seeing this because the LLC is simpler and easier to run, in most cases, than a corporation. But we still see corporations pop up from time to time. We’re going to talk today a little bit about why these things still stick around and what’s there.
Angela: I think it depends. If you’ve got foreign entities, you can’t make the S election, right? So you can’t tax your LLC if you’ve got foreign nationals or certain kinds of trusts as shareholders in your LLCs. We call them members, which seems kind of funny. “This is my member.”
R. Shawn McBride: Yup.
Angela: Kind of racy, it’s okay. You know, if you have those people, you are not going to be able to make the S election, right? So you may have to have partnership taxation or C corporation taxation. You need to kind of look at your business and see which one of those makes more sense for you.
R. Shawn McBride: Right.
Angela: A lot of flexibility, that’s what I like about them.
R. Shawn McBride: Right, and so why would people still pick a corporation, right? You have the corporation and I like to bring people through the history, right? Originally we didn’t have … 150 to 200 years ago we didn’t have limited liability entities unless you had a legislative act to cradle the limited liability entity.
Angela: Right.
R. Shawn McBride: Then things got democratized a little bit and they came up with the concept of the corporation, but the corporation is very rigid. You have to do things a certain way. You have to have a board of directors, generally. You then have to have meetings and everything is very formulaic it’s –
Angela: Secretary, treasurer.
R. Shawn McBride: Yup.
Angela: You know.
R. Shawn McBride: Very, very formulaic. You must do it this way unless you go through a whole lot of work, you’re going to do it that way. You’re going to have a board of directors, and board of directors oversee your officers and everything’s kind of laid out for you. So, you’re in this prebuilt system.
Angela: But it’s too much for most small business owners.
R. Shawn McBride: Absolutely, absolutely.
Angela: The same person ends up being “Okay, I’m the Director, I’m the Board and I’m the President and I’m the Secretary and I’m the Treasurer.” Right.
R. Shawn McBride: Right.
Angela: So you end up with the same person sitting in those roles anyways. It just doesn’t make sense. It’s like you’re trying to wedge this business into this corporate entity that doesn’t fit.
R. Shawn McBride: Well the corporation was set up 120 years ago. States started authorizing corporations with ideas of railroads and –
Angela: Oh sure. Big, this big.
R. Shawn McBride: Big national businesses that were run big and then people got forced to apply with the smaller business and we saw small businesses wanted that limited liability protection. They were then forced to have a board of directors, they were forced to have shareholders. We do have members in the LLC, or you have some sort of economic owner, but then you had Mr. or Mrs. America owning an entity and then they would have to be the shareholder, they would have to vote for themselves to be on the board of directors.
Angela: Right, but you get to have your meetings in the shower, right? Everybody says that, right?
R. Shawn McBride: Doesn’t matter where you have the meetings, right? You can take them in the shower.
Angela: In the shower or at the dinner table. “What do you think lovey? Do you vote yes?” “Yes, I vote yes.” “Okay, it’s decided, let’s eat.”
R. Shawn McBride: Yeah, I’ve had clients that have actually . . . they’ve had meetings with themselves. They’ve convened shareholder meetings and sat in an empty conference room with themselves.
Angela: Were they schizophrenic? I’m sorry, I hope it’s okay that we goof around a little bit because we want to make this entertaining for whoever’s watching. Do we have anyone watching?
R. Shawn McBride: Excellent. We have people watching. If you’re watching why don’t you send us a comment, let us know what you want to hear about.
Angela: Yeah, let us know that you’re alive out there, please,
R. Shawn McBride: Exactly.
Angela: Because it just feels like we’re bantering, which is fun, don’t get me wrong, but you know.
R. Shawn McBride: You know, Facebook live, BLIVE tv or Teleme, I’ve got people watching, so I want to hear from you guys. Pop up on comments and we’ll channel the content to you.
So we’ve got now the corporation was there, very structured, very formulaic, and at some point the State legislature came around saying “Why do we have to have all the formalities.” That’s when they came up with the LLC. Initially people were hesitant to use the LLC because they knew the corporation, they knew how it worked, they knew what the limited liability protection was and then you had this new thing on the block with the LLC and people were saying, “Is this really the same as the corporation? Am I going to be able to get liability protection? Does it make sense to use it?”
Angela: Hey, here’s some trivia. So I’m licensed to practice in Wyoming and Wyoming had the first LLC statute. I think is was 1977.
R. Shawn McBride: Yeah, it’s a very good State.
Angela: Cowboy lawyers.
R. Shawn McBride: Exactly, and they kind of set the stage and it took off like wildfire. Now we have almost 50 States recognizing LLCs and having to form with any other States and you get to pick which State you form in, which in there are different reasons to form in different States. They take away a lot of formality, they give us freedom of contract to say what do we want to do? How do we want to set it up? How do we want to manage it? We can have the board of directors like the corporation if we want, but we don’t have to. We can just have some managers, have a vote, we can have one person have control with other people having no say. We can have one person having control while other people having veto rights. We can have complete flexibility.
Angela: Yeah.
R. Shawn McBride: That’s what I love. You can get in there and engineer this company to work the way you want it to work.
Angela: Yeah, you can have operating agreements that basically, you know, you can pretty much put anything you want into them, as long as it’s not against public policy. I don’t know, has anyone tested that? Can you put stuff that’s against public policy in the operating agreement, since it’s basically a private contract between the shareholders? I mean, I guess you could but . . .
R. Shawn McBride: You could put it in there. The question is whether a court would enforce it if it ever came down to it.
Angela: Exactly. I don’t know, I’m just bantering. You know how I am.
R. Shawn McBride: Yeah. Yeah, courts typically won’t, and for those non-lawyers out there, courts won’t typically enforce something that’s not … that’s against public policy, that violates … you can’t use the court system to do something that’s unethical, that they view as being bad. So you can’t go that far, but as long as it’s ethical, as long as it’s good business you can do it in your LLC agreement and we can build that LLC agreement to do whatever you want it to do. So, that’s why a lot of people are going LLCs versus corporations.
Let’s go back and say “Why do people still do corporations?” I can think of a couple reasons off the top of my head. What have you seen Angela? Why are people still using corporations from time to time?
Angela: Well, I think we already talked about one instance where if you have shareholders that are foreign entities or certain other types of well … okay, strike that, strike everything I just said, let’s back up … one of the reasons is that if you’re going to get funding at some point from venture capital, they using like you’re using a C corp. A corporation, taxed as a C Corp. Okay, they like that.
The other reason may be to use a corporation is maybe you just want things to be a little bit more formal. Maybe you want the C corporation taxation anyway or you have to have it.
R. Shawn McBride: Right.
Angela: Because you’ve got non-citizen entities or certain kinds of trusts that are going to be shareholders, then you can have an LLC if you want –
R. Shawn McBride: Right.
Angela: But you’ll have to tax it as a C corp. So I just don’t see a whole lot of instances, when it’s more advantageous to have it as a C corp, taxed as a C corp, or organized as a corporation. You know what I’m saying?
R. Shawn McBride: It’s extremely rare. The outside investors seem to be the number one reason, right?
Angela: Yeah, they like it. They’re nervous, they get nervous about the alphabet soup.
R. Shawn McBride: A lot of funds out there, they’re just familiar with corporations, they know how they run, they want to be formed as a Delaware corporation.
Angela: Delaware. Let’s form in Delaware, right?
R. Shawn McBride: Well they don’t want to familiarize themselves with the nuances of 50 different states.
Angela: And that fine. They’re investors, they’re nervous.
R. Shawn McBride: They’re investors, they’ve got money and they do it.
Angela: They’ve got the money, exactly.
R. Shawn McBride: Actually, investors are starting to move to the LLC side of the world.
Angela: I’ve worked for a lot of medium size companies that have gone the LLC route and they’ve basically just said “Yup, this is what we’re doing.” And they’re taxing it as a C corporation, which is fine.
R. Shawn McBride: Yeah.
Angela: But, you know, that’s what they’ve got.
R. Shawn McBride: Smart investors may actually like the LLC over the corporation, because if you do it right you can even build even more investor perfections into your LLC documents then what you get on a corporate documents, with some of the veto provisions.
Angela: Yeah.
R. Shawn McBride: An investor can actually protect themselves more with LLC than they could with a corporation.
Angela: Well, and then you don’t have to go through all this nonsense of like issuing preferred stock and issuing this kind of stock and that kind of stock.
R. Shawn McBride: Right.
Angela: You know what I mean? It’s just so much easier.
R. Shawn McBride: We spend a lot of time as lawyers engineering working with the corporate code. Now the reason why we still see a lot existing today is because that engineering has been done, and has been done for 30, 40, 50 years. You’re very familiar with how that engineering is done but you’ve got layers, upon layers, upon layers of documents in the corporate situation to get to a certain task. In an LLC we can usually get an LLC done, often with two documents. You file with the State and then get an operating agreement and you build everything into that operating agreement that would take 10, 15, 20 documents, sometimes in a corporate deal, can all be put in one document. So a lot of efficiency there.
Angela: Yeah, yeah I feel the same way about them. I just think it’s so … they’re just so much easier for everybody to understand too because you don’t have to try to wedge everything into those corporate formalities, you know?
R. Shawn McBride: Exactly.
Angela: Okay we’ve got to go have a meeting, we have to cover these things.
R. Shawn McBride: Right.
Angela: If we don’t, we’re risking our liability protection and it’s just … you and I both know, Shawn, having practiced in this area, what percent of clients do you have, no names please, what percent of clients do you have that actually observe the corporate formalities required of a corporation, consistently every year. I’ll tell you what my percentage is. Zero.
R. Shawn McBride: Yeah, I think we’re running about zero, too.
Angela: We are setting them up for failure, if we form corporations for them.
R. Shawn McBride: Corporations, technically, if you read the law … if you read the law for a corporation, it says you will have a shareholder’s meeting every year to appoint a board of directors.
Angela: Yup.
R. Shawn McBride: Then you’re going to have a board of directors meeting to go over the business. These are required by law.
Angela: Yup.
R. Shawn McBride: And nobody is doing them.
Angela: No.
R. Shawn McBride: Occasionally a corporation gets hammered. Somebody will then come along and come back and they’ll use as an argument, to get to the owner’s personal assets –
Angela: Right, we want to see your records. Show me your records.
R. Shawn McBride: Show me your records, and then they say “You didn’t treat my corporation like a corporation.” One of my corporate clients just recently met with them. A family business … they’ve been in a business a long time, the corporation … and they said “Oh yeah, every five years we just go back and we do five years of annual meetings because that’s . . . what every five years, you talk to your lawyer and catch up for all the stuff you haven’t been doing.” And that’s really what’s happening in America.
Angela: Right, right. If that! That’s the best case scenario.
R. Shawn McBride: Right.
Angela: Even that, I’m like ahhh.
R. Shawn McBride: You’re not supposed to do it that way. You are supposed to be meeting every year.
R. Shawn McBride: Of course.
Angela: Besides it gives you an opportunity to go on a vacation, right? Because you’ve got to have your annual meeting someplace, right? The shareholder’s meeting.
R. Shawn McBride: Yeah, with electronic records and all too, it’s not easy to just backdate something, I don’t advocate backdating anything anymore.
Angela: Of course not. No, we don’t ever backdate.
R. Shawn McBride: Try to backdate it, and you’re going to have a record of it being backdated because it was emailed. So, you have to do it every year if you want to really protect yourself as a corporation and the reality is that most people are not going to do it.
Angela: No, they’re not.
R. Shawn McBride: Definitely a great reason to be an LLC.
Angela: Hey I see we had a question. I love it.
R. Shawn McBride: Yes we did. My friend Jim Webb. Yes, great guy.
Angela: Hey Jim.
R. Shawn McBride: He is asking about liquidity of a corporation versus an LLC.
Angela: Oh liquidity.
R. Shawn McBride: Buying and selling the shares. This is a great question. This is looking ahead a little bit, to what you are going to do with this company.
Angela: Right, right.
R. Shawn McBride: And where’s it going to go. Private companies have liquidity issues all around, so it doesn’t really matter whether you’re an LLC or a corporation, you’re probably illiquid. Many people don’t want to buy, particularly a minority interest.
Angela: Well, well hold on there a second, though. Hold on a second. Now it depends on who’s selling … we’re getting some feedback here, is that me or you?
R. Shawn McBride: No, no go ahead, I can’t hear it, but.
Angela: Okay, okay good. Okay so part of the issue with an LLC is, you’ve bought up a couple . . . so there’s minority interests, minority shareholders, nobody want to be minority shareholder, right? Because the other shareholders can oppress you. But with LLCs, a lot of times, we write into the operating agreement restrictions on who the shares can be transferred to. Right?
R. Shawn McBride: Yup.
Angela: Who can buy, who can sell and sometimes we build in either a formula that says here is how we’re going to decide the price or –
R. Shawn McBride: Right.
Angela: We say its book value, right? Book value, market value or we decide on a way to set the price. So that’s good but you know one of the great things about using these LLCs for planning, Shawn, is that we can actually write such restrictions into the operating agreement that may devalue the shares such that the shares are not worth what they might otherwise be. Although the IRS has placed some restrictions on this.
R. Shawn McBride: Yup.
Angela: On the last few years, but we can actually transfer and gift shares to other people. Other people would are permitted shareholders per the operating agreement.
R. Shawn McBride: Yup.
Angela: Gift an estate tax values that are less, and that’s a great advantage, from a planning standpoint.
R. Shawn McBride: You can do a lot of planning and we can really do the same things with a corporation but again it’s the multiple documents versus one streamlined efficient document.
Angela: Right.
R. Shawn McBride: A corporation we can sit down and we can do the same type of restrictions, we can change the value of the shares and what they’re economically worth by changing the restrictions on them. So whatever planning we’re doing we can do in a corporation but we’re going to have to have a shareholder’s agreement. So, now we’re getting into all the documents of a corporation. Now we talked briefly about LLC largely needing two documents, if you do it efficiently you’ve got a certificate and an operating agreement and you’ve got a whole layer of how you want your business run, shares transferred, and everything in one document.
Moreover, in a corporate world, there are Certificate of Incorporation filed with the state, bi-laws on how you run your meetings and your voting and all that, then a shareholders agreement with shareholders voting this way and that way. Sometimes you’ll see voting trusts, you’ll have shares certificates, and you may have resolutions authorizing all this. I mean, suddenly what could be two documents for an LLC turns into a whole binder for a corporation.
Angela: Yeah.
R. Shawn McBride: Just to get out of the box and get the thing done.
Angela: That’s crazy right?
R. Shawn McBride: It’s crazy and as a private company you’re not going to have the liquidity and you’re going to have difficulties selling your shares of a corporation or an LLC. It’s going to be the same issues.
Angela: Yes.
R. Shawn McBride: You’re selling a private company.
Angela: Yeah, it’s not like if it’s traded it’s not like things that are traded on the stock exchange where anybody can buy and sell it, that’s not how they work. Usually.
R. Shawn McBride: Privately held businesses – investors don’t want to buy minority interests in them. They want to buy the whole business, so you can still negotiate that whether you’re a corporation or an LLC, you can still sell all the assets of the business or sell all of the stock of the business, whatever you want to do.
Angela: Sure.
R. Shawn McBride: But the liquidity issues are largely the same between a corporation and an LLC, so that’s not one majority planning issues. You really want to look at what are your goals? I always start with my clients “What are your goal, what are you doing, and do you want to go public? You want go public and you really have a chance of going public and you think that’s your future, then go ahead and be a corporation. Go for it. If you think you have private equity money coming in, then a corporation. Sometimes if you’re doing some stuff foreign, you know, they’ll recognize a corporation versus an LLC differently. Going international, we’ve got to have a conversation. Beyond those types of issues, for most businesses that are being run, particularly businesses that are setting that growth phase and want to get their operations working out and keep things rolling, LLC makes sense 95, 99 out of 100 times to simplify and make things run easier for that business.
Angela: Yeah.
R. Shawn McBride: Yeah.
Angela: Yeah it’s just so much easier. Fewer moving parts.
R. Shawn McBride: Right and you know if you think you’re doing something unusual or something different, sit down with a lawyer that you like and have a conversation. Say “This is where I’m at, this is where I’m going. Should I really be an LLC? Should I be a corporation?” And most of the time I found with my clients there’s not a lot to debate. It makes sense to be the LLC and then you take it from there. You can morph too, that’s the other part we didn’t touch on.
Angela: Yeah. You can always change your mind later. It’s sometimes hard to go from a C corporation to other entities, from a tax standpoint but you can take an LLC and morph it into something else, if you want to.
R. Shawn McBride: Right and the States have even made that easier in recent years and now States have what they call a conversion statue, which allows you basically to morph your entity under State law from one type of entity to another by filing some paperwork with the State. Very easy. Used to be that we had to go through a whole rigamarole of mergers and creating a new company, by merging the old company into the new company and there was a lot of work. Some people said well some people are doing this anyways, there just doing a pile of paper, why don’t we do a conversion. Just take your LLC and make it a corporation the next day, or take your corporation and make it an LLC the next day and the States are on board with that.
Angela: Love it.
R. Shawn McBride: In many ways, with the added efficiency and the other things it has done is its allowed people to pick an entity for their current season of their business, right? An LLC for now, get to a certain level and then you can be a corporation.
Angela: I love it. I think that’s great. That’s really great. I like being able to … actually, so I used to practice … I mean I’m still licensed in Nevada, but I used to form all my entities there for my clients and then Nevada got really greedy, right? They started charging people $400 a year to form a corporation in Nevada, so I took all my corporations and I merged them into Wyoming corporations, where it’s a lot cheaper to maintain them. And it was super simple, all I did was basically form a new LLC in Wyoming.
R. Shawn McBride: Yup.
Angela: I merged the old one into the new one, and ditched the old one and that was that. It was super easy, super easy to manage.
R. Shawn McBride: That’s a whole other point for another discussion –
Angela: Okay.
R. Shawn McBride: It’s the Wyoming LLC versus Delaware versus other States. You get to pick out there when you … once you decide LLC versus corporation, you get to pick your State, and Wyoming has some great privacy benefits and they have a very good statute – other States have other benefits. We can probably talk about that another time.
Angela: Well Wyoming has what’s called the Wyoming Close Corporation, which is really great for family business planning, right? It’s intended to get around some of those restrictions that the IRS has placed on valuation discounts that we talked about a little bit earlier. But we can talk about that another time. Valuation discounts, those are kind of fun.
R. Shawn McBride: Yeah, a ton of issues. Yeah I know we’ve got some people tuned in. I want to move onto other topics. I would love everybody to join in today, if you could send a message either post on the video comments, send it to me privately, or email me or Angela. Let us know what else you want us to talk about in the future, because we’ll tailor some content to us. I think with Angela’s intellectual property background, I think we’d love to dive into that in the future. So we want to know from you what you want to hear about so that we can tailor some content for you in the future. So, thank you for tuning in today and I’m looking forward to you all. Any closing remarks Angela?
Angela: It’s been fun.
R. Shawn McBride: Good, I enjoyed it as well.
Angela: I really like this, can we do this again sometime?
R. Shawn McBride: I would love to, let’s do it.
Angela: Thumbs up, let’s do it.
R. Shawn McBride: All right. We will talk to everybody soon. You know how to get a hold of me. Find me on my R. Shawn McBride fan page and join in and let us know what you want to talk about in the future. See you all soon.
Angela: Thanks Shawn.
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