Choosing between a corporate or limited liability company structure when starting a business is an important decision you must make. Both entities provide benefits and drawbacks that may not exist with the other. Two important considerations that should factor into your decision are the differences in owner personal liability and the ease at which you can transfer ownership.
The board of directors is the governing body of the corporation and may or may not include shareholders. The board is elected by shareholders and has the authority to designate corporate officers responsible for overseeing daily operations. Unless a shareholder is on the board or is an officer of the company, she will never be liable for the obligations of the corporation. However, if a member of the board or an officer binds the corporation in a transaction that is beyond the scope of her authority, she may incur personal liability to the corporation for any resulting loss or damage.
An LLC is solely liable for debts and other contractual obligations of the business. Individual members are not responsible for the transactions they enter into on behalf of the LLC provided they act within the scope of their authority. For example, if an LLC becomes insolvent and defaults on a business loan, the lender’s only recourse is against the LLC and its assets. Members need not provide personal assets to make up for any deficiency in payments. In contrast, if a member obtains financing for a piece of equipment which the LLC operating agreement expressly prohibits purchasing, that member may be liable for the loan payments.
The corporate form is conducive to frequent and simple transfers of ownership interests. Unless there is specific corporate authority to the contrary, a shareholder may sell or exchange shares of stock in the corporation at any time. The transferee obtains any interest and right the former shareholder had. More restrictions apply to the transfer of a membership interest in an LLC. Although a member is free to assign his financial interest in the business, which includes a claim on LLC assets and profits, the member’s right to manage the LLC does not transfer. However, members are free to draft an operating agreement that permits the full transfer of all rights and interests inherent in LLC ownership.
Corporation and LLC owners both have a legal claim on a portion of business profits and assets; however, the profit payments are subject to different rules. In a corporation, the board of directors has sole discretion in deciding whether to issue a dividend to shareholders. Shareholders have no recourse in the event the board decides to retain or reinvest all earnings indefinitely. Similarly, LLC members may not force the managing members to issue a distribution of business profits. However, the members may draft an operating agreement that requires the distribution of profits when the LLC meets certain earnings goals or on the happening of some other event.