Business Law

Many people running small businesses ask this exact question, but what they are truly asking is whether they should set up the business as a separate entity in order to limit their personal liability. In almost all cases, a business should be set up as either a limited liability company or a corporation. This primarily accomplishes two things: (1) limiting the personal liability of the owners of the business and (2) defining the relationship between the owners of the business.

Limited liability is the legal concept that the owners of an incorporated business are not personally responsible for the debts, obligations or liabilities of the business. The liability of the business is therefore limited to the assets of the business, and the owners’ personal assets (house, car, etc.) are not exposed. There are exceptions to this protection, for example, when the owners fail to treat the business as a separate entity, fail to comply with state requirements, intentionally act in bad faith, or themselves negligently cause injury or damage to others.

The simple answer is that defining the relationship between the owners at the outset gives everyone clear expectations and prevents much larger and more expensive problems from arising down the road. Some quick examples of issues to consider: Who owns what percentage of the business? Who is going to run the business? Can new owners join the business (if so, who decides, and what is the mechanism)? Can owners sell their portion of the business (if so, who decides, and what is the mechanism)? Can owners have other businesses? What happens if an owner divorces? What happens if an owner dies? As you can surely imagine, addressing and answering these questions at the outset are imperative.

As an initial matter, both corporation and LLC provide the owners with limited liability protection. The legal differences between the two are in how they are structured and the formalities they are required to follow. LLCs are created by filing a simple certificate of organization and are internally governed by an operating agreement. LLCs have members (the owners) and managers. Corporations are created by filing articles of incorporation and are internally governed by a set of bylaws. Corporations have shareholders (the owners), directors and officers (president, vice-president, secretary and treasurer). In addition, corporations are required to have regular meetings of stockholders and directors, are required to keep minutes of meetings, are required to give notice of meetings, etc. In general, LLCs have fewer layers of corporate governance and are subject to far fewer formalities. Business owners should also be aware that there are various tax elections and consequences associated with limited liability entities.