Limited Liability Company
A limited liability company is kind of a cross between a corporation and a partnership. It provides easy management and “pass-through” taxation (profits and losses are added to the owner(s) personal tax returns) like a sole proprietorship or partnership–with the liability protection of a corporation. It is a separate legal entity (think “separate person”). However, there is no stock and there are many fewer formalities. The owners are “Members,” not “Shareholders.”
The heart and soul (and critical element) of a LLC is the “Operating Agreement”. This is how you keep Jimmy’s ex-wife from becoming a co-owner of the business with you. It sets the rules for operating the company and can be modified as the business grows and changes. This document requires some thought and careful planning.
The Skinny: The LLC is the entity of choice for 1-5 person companies (although even companies as large as Chrysler® are LLCs) and has surpassed the corporation in popularity. Ease of management, transfer, modification and limited formality/compliance requirements make LLCs a user-friendly entity solution.
“Doing Business As” or “DBA”
A DBA (also known as a “sole proprietorship”, “Doing Business As”, or a “Fictitious Name”) is a business that is not separate from its owner(s)—it’s just a different name that the business owner operates under. The owner(s) is personally liable for the company and its debt. If there is more than 1 owner, then the business is a “General Partnership”—kind of the worst of both worlds: each owner is responsible for all the acts of all the owners—unlimited liability!
The Skinny: Stay away. No protection, lots of potential liability.
Corporation (or C-Corporation)
A separate legal entity that can shield owners (shareholders) from personal liability and the debts of the company. A good thing, no? It can buy real estate, enter contracts, and sue and be sued – all completely separately from the owners. Ownership can be transferred through the transfer of stock. The duration of the company is perpetual–it can continue regardless of ownership. There can also be tax advantages.
Basically, a corporation is set up as:
- Shareholders own the stock of the corporation.
- Shareholders elect Directors (the “Board of Directors”).
- Directors appoint Officers (President, Secretary, Treasurer, etc.).
- Officers run the company (day-to-day operations).
In many cases–especially with startups–one person is Chief, Cook & Bottle Washer. That is, one person is often the 100% owner of the stock, who elects the directors (usually the same person) and then appoints the same person as all the officers: CEO, Treasurer, Secretary. It’s a lot of hats to wear.
The operating rules are set in the “Bylaws”. That sets the rules for the company and can be modified as the business grows and changes. Operating a corporation involves, at the minimum, holding a yearly Directors and Shareholders meeting, keeping written minutes of major company decisions and maintaining strict corporate formalities and corporate compliance as dictated by the Bylaws and laws of the state it is formed in (and operating in).
The Skinny: More complicated to run and manage than the LLC, the corporation is still the oldest (and maybe most “prestigious”?) form of entity. Formation of corporations is becoming increasing rare given the ease and flexibility of using LLCs or other forms. Electing to be an “S Corporation” (see below) makes things a little better.
More a tax decision than truly different “corporation.” A corporation may elect “S-Corporation” status by adopting an appropriate resolution and completing and submitting a form to the Internal Revenue Service (and, possibly, the state). Once complete, the corporation is taxed like a partnership or sole proprietorship rather than a corporation. There are limitations on S-corporations: for example, they may not be able to deduct some expenses like health insurance, travel, entertainment, etc.
The Skinny: Though taxed like LLC’s, S-corporations still require all the corporate formalities of a regular corporation (holding Board meetings, keeping minutes and resolutions). Like regular corporations, they may be on the path of the dodo for all but unique situations.