Frequently Asked Questions
in Business and Corporate Law
The simplest business form is a sole proprietorship. The owner is the individual. There are no documents to file, and the owner can report the profits or losses on their personal tax return. The owner is personally liable for the business.
If there is more than one owner it is a partnership, with voting and distribution of profits and losses determined by percentage of ownership.
A corporation is a formal business structure, and is a “person” in the eyes of the law. The owners are not personally liable for the acts of the company. Articles of incorporation are filed with a state, stock is issued and officers are elected.
A limited liability company (LLC) is a hybrid organization, blending corporate and partnership traits. In broad terms, it provides corporate limited liability protection for the owners, with the tax and management characteristics of a partnership.
There are a few important issues to address when selecting a business form. These include liability limitations, tax treatment of earnings, management structures and types of ownership interests.
Corporations and limited liability companies (“LLCs”) provide some personal protection from company liabilities. There are exceptions. First, a licensed professional, such as a physician, accountant, engineer or attorney is not shielded from liability for professional negligence. Second, if the owners of the company comingle business assets with personal assets and do not respect business formalities, a creditor can “pierce the veil” and obtain judgments against the individual owners.
Sub-Chapter S corporations and LLCs are known as pass-through entities. The profits and losses of the company pass through to the owners based on their ownership interests. In an LLC, however, this can be modified by agreement, and the owners, called members, can change the allocation of profits and losses.
Regular or “C” corporations are taxable entities, and distribution to its shareholders are also taxable. This is known as the “double tax” problem. But many benefits payable to shareholders in a C Corporation are tax deductible by the C Corporation, and they are not in an S Corporation or an LLC.
LLCs have an advantage over S-Corporations for real estate ventures. LLC debt can be added proportionately to each member’s tax basis, which is not permitted in an S Corporation. This increases the amount of distributions to a member that are tax free. C Corporations that own real property have another disadvantage. When the appreciated property is sold, the gain in value is taxed to the C Corporation.
C and S Corporations have formal management structures set forth by statute. The stockholders elect the board of directors who oversee the company, and the board appoints officers for the daily management of the business. LLCs can have any management form. The members can all participate in management, much like how old partnerships were operated. A manager can be appointed, to run the entire operation, or the members can have a hybrid form, such as an administrative manager, with oversight on major decisions by the members.
Finally, C Corporations and LLCs can have different types of ownership interests. For example, there can be interests without voting rights, interests with preferential distributions and interests that change when certain events occur. All S Corporation ownership units must be the same.
This is obviously a complex question, and one that should be fully discussed with your accountant and your business attorney.
First, you need sound documents: credit applications, contracts or purchase orders, and change orders. These documents should include warranty terms, payment terms, interest on late payments terms and a clear description of collection and legal fees in the event of non-payment.
Second, these documents need to be completed accurately. Nothing hurts a lawsuit more than good documents not used properly. Simple things, such as the incorrect legal spelling of the customer name, the incorrect address or a missing signature from a customer can doom a claim.
Third, proceed slowly. Take only small orders at first. Establish draw schedules for larger projects. Have employees and owners visit with the customer.
Finally, check out the customer. Ask for their tax identification number, use a service to check the payment history, or use public databases (see below). Most states have a database with real property and business information. In Maryland, use www.dat.state.md.us to see if you have the correct business name, address and spelling. You can also use it to verify who owns the real property, if you are doing improvements to the property. You can also check to see if there are lawsuits against the customer or its owners through public databases. In Maryland, use http://casesearch.courts.state.md.us/inquiry/inquiry-index.jsp.
Employee handbooks can be very useful to establish expectations and publish information about holidays, benefits, policies and employee behavior. It can also be used against the company, because it can create expectations of and obligations on the employer. For example, if the handbook contains a disciplinary process that is not followed when the employee is terminated, the handbook may create a breach of contract.
In smaller companies, consistent enforcement, updates and employee acknowledgments can be a constant challenge. Often, my recommendation is to have a series of policies that communicate the company’s vacation, sick, benefit and overtime practices. Policy statements about equal opportunity, sexual harassment, substance abuse and testing, and computer and internet use are critical items to communicate. This information should be disseminated by postings or memos, without the need to update everyone’s handbook.
It is the process where a certified professional determines the value of a company. This is done in many ways, but always includes a review of historical and current financial records and usually includes interviews of the management team, as well as a review of the economy, the goods and services sold, the competition and a study of risk factors.
Business valuations are simple for publicly traded companies, as the stock price determines its value. For private companies, which are the majority of businesses, valuations are critical components of the succession planning and estate-planning processes for the owners. Valuations are almost always required when there are disputes among the owners or an owner is in a divorce proceeding.
Succession planning requires that the owners understand the value of what they have. Whether it is to determine the life insurance necessary to fund a buy-sell agreement, enter into an employee stock ownership plan (“ESOP”) or sell the business to another person or entity, the value is the number one issue.
Additionally, a business valuation helps you answer the following critical questions: Is your business adequately insured? Is the umbrella coverage sufficient? Do you have business interruption coverage? Do you have the right key-man insurance coverage in place?
Since many private businesses are illiquid and often represent a significant percent of an owner’s assets, business valuations greatly impact how an estate plan is structured. Does the business value create an estate tax problem? If so, how do we provide funding for these taxes? How that funding is coordinated with the succession plan?
All private company owners need to understand what they own for many reasons, and then they need to periodically review and update the valuation.