putting themselves at risk by signing individually.
LLCs allow for flexible management. Either the members (owners) or the managers (the president, etc.) can run the company. They also offer flexibility in division of profits and losses. In a corporation, dividends are allocated according to percentage ownership. In an LLC, members can utilize special allocations to divide profits between members. So, for example, profits in an LLC owned 50/50 can be allocated on a 70/30 basis.
With an LLC, Articles of Organization are filed with the Secretary of State. Instead of bylaws, an operating agreement is created. As with a corporation, to avoid personal liability in an LLC you must:
• Maintain timely filings with the state.
• Prepare entity tax returns.
• Maintain a separate bank account for the business.
• Separate personal and business matters.
• Have adequate capitalization (funding) of the business.
• Hold annual meetings of managers and members.
From being brand new in the 1980’s, LLCs are now one of the most popular ways to do business and hold real estate.
Limited Partnerships (LP’s)
A limited partnership is akin to a general partnership, but offers more protection. Instead of just general partners in a general partnership, in a limited partnership there are general and limited partners. General partners (as in a general partnership) are personally exposed. A creditor can go after each and every general partner and all of their personal assets. As well, general partners face personal liability for partnership debt. Limited partners are only liable to the point of their contribution of capital to the partnership. To deal with the risk of being a general partner, an LLC or corporation can be set up to serve as the general partner in a limited partnership, thus encapsulating unlimited liability in another limited liability entity.
But, as the chart below indicates, you will need to set up two entities to be completely protected in an LP arrangement. With an LLC, everyone is protected in one entity.
When you elect to form as an LP, you’ll file a certificate of limited partnership with the Secretary of State’s office, and a limited partnership agreement will serve as the operational road map for the entity.
A chart of the good entities helps to explain the differences and similarities:
Where to Incorporate
Many people incorporate in the state where they do most of their business. And sometimes this is the best choice – but not always.
Where your business is located does not have to dictate where the business is incorporated. In fact, you might be better off choosing to incorporate in a state thousands of miles from your home office. Choosing where to incorporate is not a matter of ease of distance but, rather, ease of business.
Corporations do not receive equal treatment across the country. Every state sets its own business laws and regulations. Some states are considered business-friendly. Others, like California, are almost anti-business. A decision as simple as where your business is incorporated can make a big difference to your bottom line and your peace of mind.
Nevada, Wyoming and Delaware are states which offer a favorable corporate law and low taxes. Nevada and Wyoming have no corporate or personal income tax. Delaware taxes entities doing business inside their state. But by setting up in those states you have the benefit of a favorable corporate law without the need to pay extra taxes.
Conversely, suppose you set up a California corporation to do business in Oregon. Not only would you have to pay Oregon taxes (because you are doing business there) but you would also have to pay California’s notorious $800 per year franchise fee because you incorporated there. You won’t set up in a high tax state to do business in another state.
What if you set up a Nevada corporation for your plumbing business in Ohio? Because you are doing business in Ohio you will submit the Nevada paperwork to the Ohio Secretary of State’s office and ‘qualify’ to do business in Ohio. You will pay Ohio state taxes on your business profits. But because Nevada has no corporate tax you won’t pay any extra money in taxes by setting up in Nevada. (You will, however, have to pay Nevada’s annual fee and a registered agent fee in Nevada.)
Choosing which state to incorporate in is an important decision and may turn on what type of business you have, what your financial goals are and what the laws of your home state are compared to those of a favorable state. Be sure to consult with your professional team so that you understand all the pros and cons before you commit. As well, there is more information on these issues in Start Your Own Corporation.
Now let’s review our third case...
Case 3: Bobo and Morton
Bobo and Morton had attended prep schools from kindergarten through high school together. Morton’s full name was Morton Winthrop Trentham III. Bobo’s full name was Anstergard VanDyke McGill, but because as a very young child he made quite a scene on the Bobo the Clown local afternoon TV show, everyone called him Bobo.
The two boys came from very wealthy families. Their great-great-whatever-grandfathers had been tycoons during the Gilded Age of the 1880’s. The Trenthams and McGills had also been the original founders of The Thracian Club, a very posh country club offering golf, equestrian and yachting activities. Many well-heeled and accomplished people were members, most prominently a number of sophisticated Wall Street money managers, including financial wizard Frank Fodom. Many people wanted to get into The Thracian Club, or ‘The Club’ as members called it. Not everyone did. The list was long and the criteria rigid or, as some would say, snooty.
Bobo and Morton had no such acceptance worries. Because the two were direct descendants of the founders, they were automatic members of The Club. Yet their family members knew that Bobo and Morton would never get in on their own merits.
Morton was short and spindly while Bobo was barrel chested and hefty. Together they resembled the famous comedy team of Laurel and Hardy. The comparison did not end there.
Unlike virtually all of their prep school friends, Bobo and Morton did not go on to expensive colleges. Neither of them did well in school nor did they have any interest in prolonging the pain. While their parents were well-connected and well-funded, that was not enough to guarantee a career for the two boys. And so as their other children moved on, both sets of parents knew they would have to come up with something for the boys to do.
The Trentham family had a large dog kennel on their very large property. The boys both liked dogs. The idea arose that Bobo and Morton should run a dog breeding business. Both families liked the whippet breed, which the American Kennel Club describes as “a medium size sight hound giving the appearance of elegance and fitness, denoting great speed, power and balance without coarseness.” It was the perfect breed for the Trenthams and McGills. All Bobo and Morton knew was that these slightly built canines were miniature greyhounds that could run up to 35 miles
