Entity Formation

The law provides for an overabundance of business entities to choose from when forming or restructuring your business.  The tax, liability and compliance issues are different for each, so careful planning is essential to business prosperity.  Before delving into the different types of entities, know that using an attorney, as opposed to an incorporation service, entitles you to the attorney-client privilege.

Why does this matter?  Well, forming your company with the help of a third party can lead to personal conversations on the why and what about the company.  In addition, information about you, other companies you may have, or anything else not related to formation may or will be solicited, as part of their due diligence.  If you find yourself subject to judicial proceedings, the plaintiff’s attorney or prosecutor will compel that third-party to produce evidence or testify about you.

A non-attorney would have to comply.  Citing “company policy on non-disclsore” is inferior to a court order or subpoena.  However, attorneys can cite the attorney-client privilege and refuse to testify or produce documents.  This is because the attorney-client privilege is one of the oldest and most respected privileges enshrined in our case law and statutes.  It preserves the integrity of the lawyer-client relationship and only in the most exceptional of circumstances can it be overcome.

Formation

The following is an overview of common types of business entities in Florida:

I. Partnership

A partnership is formed when two or more people engage in business together with the intent to create a profit.  Partners have equal rights to control the business (absent an agreement to the contrary), are personally liable for partnership debts, and are taxed based on each partners’ proportional share of partnership profits.  Many business owners carry on as a partnership without realizing the liability risks associated with this entity.  For example, if the partnership defaults on a loan or obligation and cannot become current, the partners would have to personally answer for that debt.

If you currently have a partnership, whether or not an agreement exists, it would be wise to speak with an attorney regarding the restructuring of your business.

II. Limited Partnership (LP)

A limited partnership is a type of partnership, as explained above, having both general and limited partners.  General partners are subject to personal liability for partnership debts and have a right to control and manage the business.  Limited partners, however, have no right to manage and control the business and are only liable to the extent of the investment they put in.  Thus, limited partners in a limited partnership are not responsible for its debts.

Interestingly, a limited partner’s investment in the LP can consist of tangible (money) or intangible (services) property.  Again, profits and losses are allocated to each partner dependent upon that individual’s initial contribution.  It is formed by filing a certificate with the Secretary of State.

This entity is recommended for some business operations and is used frequently in asset protection plans.  Note, though, that the general partners’ personal wealth is at risk with this entity.

III. Limited Liability Company (LLC)

A limited liability company is a hybrid entity that combines the limited liability of a corporation with the tax advantages of a partnership.  The members, managers, and managing members of an LLC are not liable for the debts, obligations, or liabilities of the company.  In addition, this entity offers immense flexibility, flow-through taxation and minimal business formalities to observe.

It is formed by filing with the Secretary of State the articles of organization.  LLCs can be organized into member-managed companies or manager-managed companies.  A member-managed LLC provides for management rights in all of its members.  These rights are commensurate to their share of profits in the LLC.  Manager-managed companies provide for a manager (or managers) that makes decisions on the LLC’s day-to-day business operations.  Each member has what is called a membership interest in the LLC.

Importantly, the operating agreement of an LLC can change, limit or enhance the liabilities and duties of its members.  Therefore, properly structuring an effective operating agreement can greatly improve your chances at protecting your membership interest against external creditor attack.  This entity is highly recommended for holding liability producing assets such as real estate.  It is frequently used for asset protection purposes and is regarded as the “go-to” entity for small businesses.

IV. Corporations

The corporation, just like the LLC, is a business entity separate and distinct from its owners.  As such, the shareholders are not responsible for the debts, obligations or liabilities of the corporation.  Corporations, by default, are double-taxed: the shareholders get taxed on distributions and the corporation gets taxed as an entity.  However, if certain requirements are met, the corporation can elect to be taxed as a partnership, and benefit from flow-through taxation.

A corporation is formed by filing with the Secretary of State the required articles of incorporation.  Next, the directors (or if no directors the incorporators) must appoint officers and adopt bylaws.  The bylaws of a corporation are essentially corporate statutes that must be followed and obeyed.  Of course, the corporation must be adequately financed and any “thinly capitalized” corporations can lead to creditor problems in the future.  Corporations are also required to issue shares.

Shares represent an ownership interest in the corporation and can be divided into common stock and preferred stock.  Annual meetings must be held and a quorum must be present for shareholder acts to be valid.  Moreover, corporate books and records must be meticulously kept as to avoid any creditor attempts at piercing the corporate veil and attacking your assets personally.

These rather onerous business formalities have led to the rise in popularity of the limited liability company.  In fact, failing to observe corporate formalities can lead to the administrative dissolution of your company, thus exposing your personal wealth to much risk.  In sum, corporations do serve asset protection and business purposes well, but when compared to the LLC, seem to have more disadvantages than advantages.