As mentioned in our most recent post, this article will be exploring the advantages and disadvantages of opting to use a limited corporation when forming a business. Again, the purpose is to give you a brief overview of your options so that you can make the best decision for your business goals.
What is a Limited Liability Corporation?
This corporate structure makes it so that the owners are not personally responsible for the company’s debts and liabilities. They’re essentially hybrid entities. Limited liability corporations combine the characteristics of a partnership or sole proprietorship with those of a corporation.
Advantages of a Limited Liability Corporation Structure
- Limits personal liability. This phenomenon is possible because the corporation itself is treated as a legal entity. Therefore, shareholders are not personally liable for the debts of the corporation. As a result, if the corporation fails, shareholders may lose their investments in the corporation, but are not personally responsible for the corporation’s debts.
- Flexibility of profit distribution. What this means is that the profits of investors can be limited through different share classes and dividend payments.
- Rights and restrictions to shares can be defined. For example, you can decide between voting vs. non-voting.
Disadvantages of a Limited Liability Corporation Structure
- Tax implications. Profits are taxed within the corporation and are also taxable to the shareholders when it is distributed as dividends.
- Corporate filings and continued corporate paperwork. These include, but are not limited to, annual reports and minutes.
- Minority shareholders have rights. Amongst these rights house the ability to launch derivative actions against the company and majority shareholders.
Given the advantages and disadvantages presented in this two-part post, the question goes back to whether you’re going to choose a limited partnership or limited liability corporation business structure. Overall, the biggest distinguishing factor between the two, from a legal perspective, is liability. In an LP, the general partners are liable for the business and its debts. In a limited liability corporation, for the most part, directors are not held personally liable.
Things to Consider
Now that you’ve read about both LPs and limited liability corporations, it is important to be aware of issues that may arise when considering a shareholders agreement. The following is a list of key considerations that may help you throughout the process:
- What is the share structure?
- Should the agreement be unanimous and involve all (or just some) of the shareholders?
- Who owns (or will own) shares (i.e. the parties to the agreement)?
- Who is on the board? What about outside board members?
- Who are the officers and managers?
- How will ownership buyouts be handled? (e.g. shotgun clause approach vs. voluntary sale approach)
- How will disputes be resolved among shareholders? (e.g. arbitration clause)
- How will share sales be handled? (e.g. first right of refusal)
- What are the shareholders’ obligations and commitment?
- What are the shareholders’ rights? (e.g. what information, financial statements, reports, etc. can they access?)
- What are the operating guidelines or restrictions? (e.g. budget approvals, spending limits, banking, etc.)
- What types of decisions require unanimous board and/or unanimous shareholder approval?
- What could trigger the dissolution of the business?
- Who are the company’s professional advisors?
- Are there any financial obligations by shareholders? (e.g. bank guarantees, shareholder loans, etc.)