Buy-Sell Agreements go by different names (Shareholders Agreement, Operating Agreement, Partnership Agreement, for example), but they all have a common goal: provide a clear roadmap for the company and owners to deal with changes in ownership, with minimal impact on the operation and value of the business. Bad Buy-Sell Agreements—those that do not minimize the impact of a change in ownership—share one or more of the following three mistakes. Mistake #1: Cookie-cutter terms that just don’t work. It’s a mistake to think that a generic Buy-Sell Agreement is just fine for every company. The terms of a Buy-Sell Agreement must fit the unique characteristics of the company. These unique characteristics may include unequal ownership interests, differing roles in the company, particular family relationships among owners, and industry-specific requirements. Unless the Buy-Sell Agreement takes into account all of the particular aspects of the company and its business, it’s likely that the Buy-Sell Agreement will fail when it is most needed. The Solution: Every Buy-Sell Agreement must be carefully prepared to reflect the unique characteristics of the company and its owners, and it should be regularly reviewed and updated. Mistake #2: Determination of the buy-out price is unreliable. Because Buy-Sell Agreements are about the buying and selling of the company’s ownership interests (stock, membership units, partnership interests, etc.), price matters. If a fixed price set in the Buy-Sell Agreement is too low, then the selling owner (or his or her family) suffers. If a fixed price set in the Buy-Sell Agreement is too high, then the buying owners or the company suffers. For this reason, it’s a mistake for the Buy-Sell Agreement to state a fixed price for the company’s ownership interest, unless the parties are required to update the price regularly. It may be better for the Buy-Sell Agreement to contain a formula to determine the appropriate price, but even a formula can lead to problems if it depends on wrong or outdated presumptions. Because of the problems associated with stating a fixed price or a formula, many Buy-Sell Agreements require an appraisal at the time of a transfer of ownership interests. An appraisal approach might be better, but it too can suffer from problems, such as failure to specify what facts the appraisal should take into account or gaps in the procedure for determining the price by appraisal. The Solution: Whether a fixed price, formula, or appraisal, the price provision of every Buy-Sell Agreement must accurately reflect the specific nature of the company and it must be flexible and subject to periodic update. Mistake #3: No assurance that cash will be available to pay the buy-out price. Even if a buy-out price is determine appropriately, the buyer—the other owners or the company—must have the ability to pay it. Unless the Buy-Sell Agreement provides specific terms for the timing and source of paying the buy-out price, the buying owners or the company may be legally obligated to pay the whole amount immediately from operating funds. This debt obligation could cripple the company or the remaining owners. The Solution: Every Buy-Sell Agreement should specify the intended source of funds for paying the buy-out price—often including life insurance and disability insurance policies—and a reasonable time period for payment of any unreserved amount. Common Elements of a Good Buy-Sell Agreement Buy-Sell Agreements should be unique documents, reflecting the particular characteristics of the company and its owners, but good Buy-Sell Agreements share most of the following common elements. Good Buy-Sell Agreements: Prohibit transfer of ownership interests except as specifically provided; Deal with the transfer of ownership interests in the following scenarios: voluntary transfer by an owner; involuntary transfer by an owner (caused by divorce, bankruptcy, or creditor action, etc.); death of an owner; disability of an owner; termination of employment of an owner; and irreconcilable deadlock among owners; Spell out the procedure by which buy-out may occur in each scenario; Describe the method of determining the appropriate buy-out price; Describe the source of funds for payment of the buy-out price (e.g., insurance); Describe payment terms; and Describe what should happen pending buy-out. Most important of all, no Buy-Sell Agreement is a good Buy-Sell Agreement unless it is signed by all of the owners, including persons who become owners after the Buy-Sell Agreement is originally signed. Do you have a good Buy-Sell Agreement? If you’re not absolutely sure, contact BrewerLong to have your Buy-Sell Agreement reviewed by an experienced small business attorney.
Selling a business can be lucrative but it’s complicated. Consider these points: What are You Selling? Early in the negotiations, buyer and seller must agree on what is being bought and sold—company stock (or other equity interests) or business assets. Ordinarily, the seller would prefer to sell the company stock, because that will make unknown company liabilities the buyer’s problem (subject to seller’s indemnification commitment). However, the seller might favor a sale of business assets because getting the cooperation of all the stockholders and option holders might be difficult. Don’t be Coy. Be open and honest in responding to the buyer’s due diligence investigation requests. Every company has taken shortcuts along the way which it might not want to disclose, but the consequences for misleading a buyer are much worse. Expect to put a lot of time and work into responding to due diligence, have a good Non-Disclosure Agreement, and let the buyer have at it. The Straight and Narrow. Avoid general, open-ended representations and warranties in the sale agreement. Certainly, there are some issues for which seller “should know,” and reps about these issues are just about risk allocation. But whenever you can get away with it, the seller should keep its reps and warranties as narrow and focused as possible. “To seller’s best knowledge” is a welcome (if rarely accepted) qualifier. Run Out the Clock. The seller should expect to indemnify the buyer for costs or losses resulting from the inaccuracy of seller’s reps and warranties. However, the obligation to indemnify the buyer should not go on forever. The seller should limit the time period for its indemnification as much as possible. Often, different indemnification periods will be appropriate for different potential liabilities. Taxes as Usual. Sale of the business will likely result in a lot of taxes. There’s capital gains tax on the sale of the stock or business assets, which could be quite high if basis is low. The seller is responsible for his or her own capital gains taxes, but responsibility for other taxes is negotiable. The seller and buyer should agree on responsibility for sales taxes, documentary stamp taxes, or intangibles taxes, if they apply. Delayed Gratification. The seller would probably love nothing more than getting a big check at the closing table, but the buyer might insist on holding back part of the purchase price. This might be because an accurate value for the business cannot be determined until all the numbers are in for a given period. Holdbacks are sometimes reasonable, but the seller should insist that the money is placed with an impartial escrow agent. Something for Nothing. Remember how happy your employees were when they got those stock options? Don’t expect them to remember now. Unless they’ve completed the “incentive stock option maneuver” perfectly, your employees are going to have a big tax bill on the exercise and sale or redemption of their option stock. And they won’t be happy if they have to wait on a holdback either. Unbind the Ties. Most business owners, when the business is growing, are required to personally guaranty every bank loan, trade credit, and other obligation of the business. The seller must be sure to negotiate a release of all of those personal guaranties as part of the sale. If a creditor refuses to release the seller, the buyer should at least indemnify the seller for liability resulting from the personal guaranty. Trust But Verify. Often buyers will want to pay part of the purchase price in installments over a period of time. Now the seller needs to be the cautious trader. The seller must conduct its own due diligence investigation of buyer’s ability to pay. The buyer’s obligation should be documented in a promissory note (on which doc stamp taxes are paid) and secured by the purchased stock or assets. A New Hat. Buyers often insist on the seller continuing to work or consult for the business for a period of time. This requires a separate agreement between the buyer and seller, which should be fully negotiated and documented at the time of closing on the sale. Especially watch out for non-competition restrictions.
Ready to hire? Keep these ten points in mind before you begin the background check process: Brushes with the Law. An employer who obtains a satisfactory criminal history check on a job applicant is presumed to not have liability if the person later commits an intentional tort (a civil wrong that causes someone else to suffer loss or harm resulting in legal liability for the person who commits the tortious act). Criminal history record checks may be obtained from each county in Florida and from the Florida Department of Law Enforcement. Separately, employers can also check a job applicant’s name against the outstanding warrants and sexual offender databases. Spanning the Twitterverse. Facebook, LinkedIn, Twitter and other social media sites may provide a trove of information about job applicants. There’s no law against searching social media sites. However, these sites are likely to contain information—race, religion, sex, marital status, etc.—which cannot be grounds for non-hiring for many employers. Sue Happy. An employee who is involved in numerous civil lawsuits may not be ideally suited for the job. Employers may check the civil court records of each county in Florida to determine whether a job applicant has sued or been sued in civil court. Credit Checks in the Red. Federal law requires employers to obtain written consent before obtaining a job applicant’s credit report. If the employer decides not to hire the person based in part on the credit report, he or she must be provided with a copy of the report. Making the Grade. Federal and Florida laws make student education records confidential. However, employers can require job applicants to provide school transcripts or verification of enrollment. Degree or enrollment verification is available through most schools or third-party providers like National Student Clearinghouse. It Stays in the Exam Room. Medical records are generally confidential under both federal and Florida law. Employers can ask applicants questions about their ability to perform specific job duties, but employers cannot ask for medical records. Right to be Bankrupt. Bankruptcy records are a matter of public records, so it is possible for employers to determine whether a job applicant has declared bankruptcy. However, federal law prohibits most employers from discriminating against an applicant because he or she filed for bankruptcy. Got Hurt and Can’t Work. Employers should be concerned about abusive workers’ compensation claims, which can increase employers’ insurance premiums. Workers’ compensation claims are public records in Florida. Employers that obtain the necessary release form can search for job applicants on the Division of Workers’ Compensation Claims Database. License to Drive. When job duties involve driving, Florida employers should require job applicants to provide written consent allowing the employer to obtain the applicant’s driving record. Without consent from the applicant, an employer may only obtain a driving record to verify information provided by the applicant. Cannot Tell a Lie. In most cases, federal law prohibits asking job applicants to submit to a lie detector (polygraph) test. There are a few exceptions when hiring for specific positions, such as armored car drivers and pharmaceutical distributors.
Personal guaranties are common with business loans. Before you sign, know these ten facts about personal guaranties: This Time, It’s Personal. A personal guaranty is a promise to be personally responsible for the obligation of another person or company. The person or company to whom the obligation is owed—usually a lender—can enforce the obligation against the guarantor just like the original obligor. Would You Loan Money to a Teenager? No, neither would a bank. Unfortunately, banks look at your new business and see a teenager. Lenders want an “adult” to co-sign for their loan—often the owners of the company. Keys to the Gate. If the limited liability aspect of your corporation, LLC, or LLP is a wall between your business activities and your personal wealth, a personal guaranty is the key to the gate. Personal guaranties make sure that you are “all in.” Good for the lender, bad for entrepreneurs looking for a fresh start. It’s Your Problem. Banks often require a number of people to personally guaranty the same obligation. These guaranties are usually “joint and several,” meaning that the bank can enforce payment of the whole amount against one of the guarantors. It’s up to that poor guarantor to go after reimbursement from the other guarantors. Ties that Bind. You can dissolve your marriage or your business partnership, but that has no impact on the personal guaranties made by the parties. As a result, you may still be responsible for your ex-spouse’s or your ex-partner’s debt. You can ask the lender to release the personal guaranty, but it’s not likely to happen. Changes. Often, a change in the circumstances of a guarantor triggers a default under the obligation. So if the uncle who guarantied your loan dies, becomes disabled, or files for bankruptcy, you could get a demand for full payment from the lender. Beyond the Grave. Personal guaranties survive the death of the guarantor. This means that, after the death of the guarantor, the guarantor’s estate might still be liable under the guaranty. Remember to give the lender notice in a probate administration. Bankruptcy Protection. Liability under personal guaranties can be discharged through the personal bankruptcy of the guarantor. That’s a good “out,” but the consequences of a personal bankruptcy are far-reaching. Pawn Kings. To avoid having to make a personal guaranty, you have to convince the lender that your business is good for the money. The most common way of doing this is through the pledge of other valuable collateral—just like a pawn shop. It helps to have a good credit history, too. No Guaranty. Personal guaranties are great for lenders, but they’re no slam dunk. A lender seeking to enforce a personal guaranty has to track down the guarantor, sue him or her personally, prove that the guarantor is liable for the debt, and then enforce the judgment against the guarantor’s unprotected assets, whatever they are. It’s a long, costly process, and the guarantor is likely to fight it every step of the way.
Even small, simple operations have plenty of moving parts. Use these ten key points to keep your company running smoothly, protect your assets, and avoid litigation. The Must-Have. Don’t go into business with others unless you have an Owners’ Agreement. You can’t see the future, and you can’t be certain that you and your business partners (or their spouses or heirs) will always agree on everything. Why So Formal? Company formalities are important to limiting your personal liability for the company’s obligations. Have separate company bank accounts, separate company financial records, separate company e-mail addresses, and whatever else needed to clearly separate the company’s life from your personal life. If you don’t respect this separation, the courts might not either. This Time, It’s Personal. Lenders and financing companies almost always require the owners of a closely held business to sign personal guarantees. This means they can sue the company, the owners, or both. Do what you can to limit personal guarantees. If you leave the company, understand what happens to your personal guarantees (and try to terminate them). Get Secure. Unless you get paid in full at the time goods or services are delivered, get security for future payments. Security might take the form of an escrow deposit, a personal guarantee, a bank letter of credit, or a pledge of the purchased goods or some other collateral. Whatever the security, have a written agreement that clearly states your rights in case of nonpayment. Business Straight-Jackets. In many cases, restrictive agreements are enforceable (provided they are reasonable in duration and geography). Know what restrictive agreements apply to you and the people you hire. Use restrictive agreements yourself to ensure that the person you hire today isn’t competing against you tomorrow. Protect the Good Stuff. You don’t have to be the latest dot-something tech company to have valuable intellectual property. IP may include your name, slogans, website, plans, and just about anything else you (or someone else) has thought of. If someone else develops your IP (that web designer, for instance), make sure the creator assigns all the rights to you. What’s in a Name? Not much, when it comes to “independent contractors” or “employees.” Whether a person is an employee (which requires tax withholding and other administrative burdens) or an independent contractor (which doesn’t) depends on what he does and how he does it. If you can tell a person how, when, and where to do her job, she’s probably an employee. The Tax Man Cometh. Collecting taxes and delivering them to the taxing authority is a big deal. Employment taxes you withheld and sales taxes you collected are not yours, they belong to the government. The government will get them, with penalties and interest (or worse!) if they’re late. Fresh Stock for Sale! Selling equity (stock, units) in your company may seem like a great way to raise capital. It’s also a great way to have financial investors and security regulators looking over your shoulder. Don’t sell equity if there’s a better way, and there’s probably a better way. Here’s the Catch. Even if you have the right written agreements, it costs money to enforce them. Your agreements might provide that legal fees and costs go to the prevailing party (most of them should), but you won’t get that until the end (and only if you go to court). Litigation is always an expensive last resort.
Unless you’re a sole proprietor, you need an Owners Agreement to guide your company through daily operations and special situations. Unless You’re Microsoft, You Need an Owners Agreement. Having an Owners Agreement is important for every non-public company with more than one owner. Owners Agreements go by different names—Shareholders Agreement or Buy-Sell Agreement for a corporation, Operating Agreement for an LLC, Partnership Agreement for a partnership. Whatever it’s called, it’s essential. “We Already Have Bylaws.” Great, but they are not the same thing. Bylaws deal with the internal management of a corporation and the relationship between shareholders, directors, and officers. Owners Agreements have a different focus: the relationship among shareholders. The Owners Agreement is much more important for a non-public corporation. LLCs and partnerships don’t even have bylaws. Protection From Unknown Unknowns. What happens to the business when personal tragedy strikes one of its owners? Personal liability, bankruptcy, divorce, disability, death—any one of these events in the life of an actively involved owner can cripple the business unless precautions are taken in advance. Those precautions belong in an Owners Agreement. Know Your Partners. You trust your business partners, but how about their creditors or ex-spouses? An Owners Agreement is needed to ensure that the ownership interests (stock, membership units, partnership interests, whatever they’re called) do not wind up in the wrong hands. Deadlock! You and your business partners are reasonable people, but sooner or later even reasonable people disagree. This isn’t a problem for the U.S. government or large corporations where the voting process (usually) ensures a winner, but what if there are only two owners of the company (or four, six or eight, etc.)? The Owners Agreement can include more creative solutions to deal with deadlocks. Competition—Good for the Market, Bad for your Business. Having put time and resources into building the business, the last thing you want is for your business partner to compete against the business. On the other hand, you might not care if your business partner has a side business. What’s allowed and what’s not in the way of extracurricular business activities should be addressed in the Owners Agreement. Like Old Fish. If an employee-owner quits or is fired, the last thing anyone needs is for her to hang around. If she keeps her ownership interest in the company, that’s exactly what can happen. The Owners Agreement should require a buy-out. Not the Time for Haggling. The Owners Agreement should address the purchase price and payment terms for the buy-out of an owner’s interest, whatever the triggering event. Unless you keep loads of cash lying around—“just in case”—you or your business might suffer from an unexpected obligation (or opportunity) to cash out an owner. By the way, how much is that ownership interest worth anyway? Bells and Whistles. Sometimes the cookie-cutter, default rules of a corporation are just fine, but often you and your business partners want things your way. LLCs or partnerships are especially flexible and allow customization. All this customization must be provided in the Owners Agreement. They Grow Up So Fast. As your company grows, your Owners Agreement may not fit so well (like my children’s clothes). Every few years, it’s important to review and update the Owners Agreement to make sure that it continues to fit your company.
Whether you’re just starting or you have an existing company, you may be considering forming an LLC. Here’s what you need to consider before you do: Corporate Gymnastics. LLCs are a flexible form of business entity with fewer mandatory rules than apply to LLCs than to corporations or partnerships. However, this flexibility means that all of the details governing each LLC must be spelled out in long, complicated Operating Agreements. Limited Liability. Like corporations and (some) partnerships, LLCs offer their members limited liability. Each member of an LLC may lose his or her investment in the company, but the member’s other property should not be subject to the LLC’s liabilities. Of course, creditors know this too, so members are often required to personally guarantee loans and other obligations of the LLC. The Rule Book. An LLC and its members are governed by the Operating Agreement. The Operating Agreement should cover such topics as management of the LLC, capital contributions from the members, distributions of net profits, and ultimate liquidation of the company. Upper Management. An LLC can either be managed by its members or managed by one or more managers who might or might not be members. Even where an LLC is manager-managed, there are usually some decisions that must be made by the members (such as a sale of the LLC). LLCs do not usually have traditional corporate officers (like president, treasurer), but they can. Ante Up. The investments members make in the LLC are called capital contributions. Capital contributions can be cash or anything of value. A key term of the Operating Agreement is whether existing members can be required to make additional capital contributions. Pride of Ownership. Unlike corporations, in which ownership is evidenced by stock, ownership in LLCs may be denominated and evidenced in many different ways. A member might simply own a percentage interest recorded only on the LLC’s books, or a member might own membership units or shares that are represented by certificates. Returns on Investment. Net profits of the LLC are generally paid to some or all of the members in the form of distributions. When and how distributions are made should be addressed in the Operating Agreement. Members can divvy up the profits in almost any way imaginable. Pick Your Poison. By default, LLCs (those with more than one member) are treated like partnerships for income tax purposes, but they can instead elect to be treated like corporations (even S corporations). LLCs with only one owner are completely ignored for income tax purposes, meaning that they are lumped together with their owners. Taxing Calculations. The taxation of partnerships, and therefore most LLCs, is very complicated. The LLCs do not pay taxes themselves (in most cases), but they do have to file tax returns. Net income passes through to the LLC’s members in the form of allocations to member capital accounts, which must comply with very detailed tax rules. Bottom line: have a good CPA. Charge! When a corporate shareholder is sued, it’s possible that a judgment creditor could end up controlling the shareholder’s stock, including the right to vote. In an LLC, the judgment creditor of a member is only entitled to a charging order, which is the right to receive distributions when and if paid. The judgment creditor of an LLC member cannot participate in the management of the LLC.
Joint ventures let you take advantage of the fundamental concept of strength in numbers. These ten points will guide you as you create and define your joint venture. Synergy. “Joint venture” is a generic term referring to any business activity carried on with the active involvement of more than one company or person who share the profits or losses. Importantly, the term “joint venture” means something different to everyone. Proposing a joint venture is the beginning of the negotiation, not the end. What’s the Point? In general, a joint venture can be appropriate when several parties can combine their unique skills, opportunities, or attributes to meet some business goal that could not be met by any of the parties acting alone. Every joint venture should have a specific purpose—the more specific, the better—and the specific purpose should be described in a written joint venture agreement. A joint venture differs from a general business company because of its specific, limited purpose or term. Define the Relationship. A joint venture can be structured as a contractual relationship or a partnership, or something in between. There are several important differences, including taxation, sharing of liabilities, and authority to bind the parties. Given the particular purpose of the joint venture, one structure or the other will be more appropriate. Feet to the Fire. Each party to a joint venture should have specific obligations and duties drawing on the particular skills, opportunities, or attributes of the party. This is the purpose of the joint venture, so the obligations and duties should be spelled out in great detail. The written joint venture agreement should also spell out how each party’s performance will be evaluated and what happens if a party does not deliver. How Does It End? The written joint venture agreement should specify when the joint venture will end. The end can either be a specific date or the happening of a specific event. Unlike a general business company, the joint venture should not be expected to continue for an indefinite period, unless the joint venture agreement includes a mechanism for the parties to terminate the joint venture. Joint Custody. Intellectual property is often produced by a joint venture. Who owns it? The written joint venture agreement should be specific about who owns any intellectual property. If the parties will jointly own the intellectual property, the joint venture agreement should describe how the intellectual property will be used during and after the joint venture. The Fruits of Labor. The manner in which parties to the joint venture share profits and losses is closely related to whether the joint venture is closer to a contractual relationship or a partnership. In a contractual relationship, each party keeps the profits or bears the losses from its own contribution to the joint venture. In a partnership structure, the profits and losses of the joint venture are aggregated and shared by the parties. Bullet Points. Because joint ventures are very specific, very customized relationships, the parties should focus on negotiating the key terms of the joint venture before producing a formal written joint venture agreement. A Term Sheet, Letter of Intent, or Memorandum of Understanding is a good way for the parties to focus in on the key terms without getting bogged down in details. Joint Venture Personified. If a joint venture will be structured as a partnership, it is probably best for the parties to create a new limited liability company (LLC) to embody the joint venture. Structuring the joint venture as an LLC can help the parties with the management of the joint venture, the sharing of profits and distributions, and the filing of tax returns. Is there a Better Way? While joint ventures can be profitable relationships, there may be a better way. Each party should ask some important questions: Why will our ordinary way of doing business not work in this situation? What new or different risks will we face from the joint venture?
If you’re looking for ways to raise capital for your company, you may consider crowdfunding. These ten facts will help you decide if crowdfunding is right for you. Come Together. Republicans and Democrats in Congress came together to pass the Jumpstart Our Business Startups (JOBS) Act of 2012, and President Obama signed it into law on April 5, 2012. The stated purpose of the JOBS Act is to ease the burden on smaller companies looking to obtain capital from public and private sources. The JOBS Act makes crowdfunding legal. Who Needs a Mil? The newly created crowdfunding exemption allows a small company to sell up to $1.07 million worth of the company’s stock or other ownership interests within a 12 month period. It Takes a Crowd. Crowdfunding investors are limited in how much they can invest in each company. For investors with annual income or net worth less than $107,000, the limit is $2,200, 5% of annual income, or 5% of net worth, whichever amount is greatest. For investors with annual income or net worth of $107,000 or more, the limit is $107,000. The numbers are set to adjust for inflation every five years. A Portal to Jump Through. Companies can’t tap into the crowd on their own. Crowdfunding offerings must be conducted through a registered broker or a registered funding portal. FINRA approved funding portals include SeedInvest, NextSeed, MicroVentures, and Wefunder. The broker of the funding portal is responsible for ensuring that crowdfunding investors are qualified and provided information about the company. Keep it Quiet. Companies cannot advertise their own crowdfunding offerings, except to direct potential investors to their designated broker or portal. Hold On Tight. Crowdfunding investors are required to hold onto their investment in the company for at least one year unless they sell to the company, an accredited investor, a family member, or as part of an IPO. Let the Sunshine In. Companies must file information with the SEC, including the names of directors, officers, and majority shareholders, a description of the company’s business, a description of the company’s financial condition (including other offerings), and financial information. The same information must be provided to each crowdfunding investor. Rights for All. Each crowdfunding investor will have rights in the company provided by state law and organizational documents. These rights might include the right to vote on the election of directors and certain actions, the right to review the company’s financials, and the right to demand a fair repurchase price. The SEC’s anti-fraud regulations also apply to crowdfunding offerings. So Long “S”. S corporation status generally requires that a company have no more than 100 shareholders and excludes most other companies as eligible investors. A company with these restrictions might have a hard time raising significant capital through crowdfunding. What Else You Got? Crowdfunding is not for every company. Fortunately, there are numerous ways for a growing company to raise need capital, including “friends and family” financing, commercial and private loans, intrastate offerings, and federally exempt private offerings. A company should review all of the alternatives before deciding on crowdfunding.
Though you can be in business without setting up a legal entity, we don’t recommend it. The following points will help you decide on the best entity for your operation. Human Error. Carrying on business without a business entity means that each of the owners is 100% personally responsible for all of the business’s liabilities. That isn’t good. A business entity [corporation, limited liability company (LLC), or limited liability partnership (LLP)] protects the owners from personal liabilities, except professional liabilities and personal wrongdoing. Pass the Buck. The tax code divides corporations into C corporations and S corporations. The main difference is that with C corporations, the corporation pays income tax on its net income and the shareholders also pay income tax on dividends. With S corporations, such as LLCs and LLPs, only the shareholders pay income tax on the corporation’s net income. Exclusive Owners’ Club. S corporations have strict rules about who can be shareholders: no C corporations, LLCs, or LLPs; no trusts (with a few exceptions); no non-US residents. S corporations may have a maximum of 100 shareholders. Even if you’re not planning to have these types of owners, the S corporation owner restrictions can limit (or make more costly) future opportunities to sell stock to new investors or take advantage of common estate planning techniques. Charge! It is possible for creditors of a corporation’s shareholder to take the corporate stock in satisfaction of their debts. Generally, the same is not possible for interests in LLCs or LLPs. Creditors of an LLC member or LLP partner are limited to a charging order, which means that creditors can receive distributions from the LLC or LLP, but they do not get control. Head of the Class. For C corporations, LLCs, and LLPs, it is possible to create different classes of stock or interest that entitle the owners to different rights. For instance, classes can differ on distributions, participation in management, and liquidation rights. S corporations cannot have different classes of stock, other than voting and non-voting stock. All Good Things. Every partner in a partnership (whether LLP or general partnership) has the right to withdraw from the partnership at any time. It may be a breach of the partnership agreement, but a partner’s withdrawal might still result in the dissolution of the partnership. Corporation shareholders and LLCs members do not have the right to withdraw unless this right is provided in an owners’ agreement. Gainful Employment. Profit distributions from an S corporation are not subject to employment taxes, provided owners who work in the business are also paid a reasonable (taxable) wage. Profit distributions to the working owners of an LLC or an LLP are subject to employment taxes, whether or not the owners also receive wages. Healthy, Wealthy and Wise. Payments for health insurance and other fringe benefits are generally deductible by a C corporation, regardless of the recipients. Health insurance and fringe benefits provided to the owners of an S corporation, LLC, or LLP are not deductible generally. Keep it Simple. A separate income tax return must be filed for each separate business (except a sole proprietorship or 100% subsidiary), even though S corporations, LLCs, and LLPs generally do not pay taxes themselves. The corporate income tax returns are relatively simpler than the LLC and LLP income tax returns because LLCs and LLPs are governed by complicated rules about the allocation of profits and losses. Changing Course. If circumstances require a change in the choice of entity, it’s almost always possible, at a price. The laws in most states now have simple filing procedures for converting from one type of entity to another. That’s the easy part. But conversion might trigger taxes, especially when converting from a corporation to another entity.