In this lesson, you’re expected to learn about:
– a Limited Liability Company (LLC)
– the difference between a partnership, corporation, and LLC
A Limited Liability Company (LLC) is a hybrid business organization that combines certain characteristics of both a partnership and a corporation.
The “operating agreement” is the agreement between the LLC owners (called “members”) to govern its business. Although state statutes typically provide “default” rules for how an LLC will be governed, the LLC members have tremendous freedom to elaborate the operating agreement, according to their specific needs.
Usually, internal affairs among the LLC members are governed by partnership law.
Similarity to Corporations
Some of the characteristics of an LLC that are similar to corporations are:
• Limited liability of its members
• Centralized management
• Transferable interests
• Continuity of life
Formation of an LLC
Unlike a general partnership, which may be created informally, an LLC must be registered with a state and requires completion and filing of a statutory form.
Management and Liability
The management of an LLC can be:
• Member-managed: all members may operate the business and are both principals and agents – more like a partnership.
• Manager-managed: business is operated by elected officers (designated members, outsiders or a combination of both) who are agents of the members – more like a corporation.
Regardless of whether LLC members exercise control over the company, they always enjoy limited liability, which means that they cannot be held personally liable for the company’s debts or liabilities.
Since 1997, the American Internal Revenue Service (IRS) treats an LLC either as a corporation, a partnership or a sole proprietorship, depending on elections made by the LLC and the number of members:
• As Partnerships: the LLC income will “pass through” the business to the LLC members, who will report the information on their personal tax returns. The LLC is not a separate tax entity.
• As Corporations (for a multiple-member LLC): a separate legal entity is created and there will be double taxation. Income will be taxed at both the corporate and the personal levels.
This separation gives a corporation a life of its own, and the responsibility and accountability to laws that are attributable to a natural person. Consequently, a corporation may own property, make contracts, be punished for its crimes, sued for its torts, and held accountable for its contracts.
• Legal personality: it is an independent legal entity separated from its shareholders.
• Limited liability of shareholders: except for special cases, as a rule, shareholder’s liability is limited to their investment.
• Indefinite life: it takes a majority of shareholders to dissolve a corporation and reduces the likelihood of opportunistic dissolution. Modern corporations are usually granted perpetual existence, although corporate existence may also be for a limited period of time.
• Free transferability of share interests: there is no restriction on a shareholder’s ability to sell his/her stake in a company without permission from others.
• Management appointed by shareholders.
• Centralized management: decision-making is governed by a board of directors.
Thus, limited liability encourages otherwise risk-averse investors to invest in risky ventures and permits perpetuity in conducting business.
1) Public Corporation: formed to meet a governmental or public purpose.
2) Private Corporation: formed to meet private purpose, meaning its owners’ interests.
• The so-called “hybrids” are corporations that have features of both public and private corporations – i.e., corporations with “public utilities,” which are privately owned businesses created for public purposes.
Some public companies were originally closely-held companies that went public by issuing securities through an initial public offering (IPO).
Disadvantages: increased regulatory scrutiny and less control for majority owners and company founders. Publicly-held companies must meet mandatory reporting standards as regulated through government entities.
Its shares are held by relatively few people, frequently members of a family. Its stock is not publicly traded on the stock exchange or over-the-counter market on a regular basis, and the law may permit restriction on stock transfer by agreement between the shareholders or by charter provision.
This type of corporation has elected a special tax status with the IRS. It is organized to minimize the effects of federal income taxes on small business, principally by doing away with corporate “double taxation” (taxation applied to the corporation’s and to the individual shareholder’s income in the form of earnings and dividends).
This type of corporation does not pay a corporate income tax on earnings; the entire income is taxed with shareholders, whether distributed or not.
The C-Corporation is the standard corporation. It is a separately taxable entity that files a corporate tax return and pay taxes at the corporate level.
Usually created by lawyers, accountants, doctors, engineers or other professionals in order to gain corporate tax advantages.
• borrow money through the issuance of debt instruments; and/or
• sell ownership in the corporate entity by issuing equity securities.