In our first Vets to Ventures article, we provided the know-how to start your next mission of being an entrepreneur and why veterans can make effective corporate leaders. Now, let’s discuss how the different corporate structures have advantages and disadvantages, all dependent on your business's specific circumstances and goals. You must choose a business structure before it is registered with your state.
Military veterans own almost 2 million businesses and employ over 5 million Americans (U.S. Chamber of Commerce, 2023).
For several reasons, forming a business entity is a critical step to the beginning of your corporate venture. A properly formed entity protects business owners from liability, presents a professional image of trust and accreditation to customers and the general public, provides structure to business operations, and may offer tax advantages. Forming an entity may also be required for purchasing business insurance. The proper entity selection will depend on your business, how you want to operate it, and the end goal. The most common entity types are a limited liability company (“LLC”) and corporations.
A common business form many use in the beginning is a “sole proprietorship,” which refers to an individual doing business without any corporate structure. A sole proprietorship is, therefore, unincorporated and is not a legally separate entity from the person doing the business. Although a sole proprietorship may be suitable for small side-hustles, it doesn’t cut it for a serious business.
LLCs and Corporations are two of the most common business structures. There are also sole proprietorships and partnerships. The IRS has a “Choose Your Business Structure” website that lays out the differences among all business entities as a valuable resource for veterans and all would-be business owners.
LLCs vs. Corporations
LLCs and Corporations are separate legal entities from their owners and protect the owners from much, but not all, legal liability. The most notable differences between them come down to who runs the company and how they operate.
Advantages of an LLC:
LLCs come without a ton of corporate formality; they are practical for small businesses and allow for flexible management structure and adaptability. To form an LLC, you file a formation document with the Secretary of State (or similar office) in your state.
- Limited personal liability: Ownership in an LLC is held by the members. The personal assets of members are more likely to be protected if the LLC faces legal or financial challenges. However, you are liable for your own actions. It is important that you are taking actions under the LLC not in your own name.
- Tax advantages: LLCs are initially taxed as a sole proprietor or partnership (depending on the number of members), but the owner may have the option to be taxed as an S-Corp or a C-Corp. Therefore, owners can take advantage of favorable tax structures to avoid double taxation, which can occur when corporations are taxed at both the entity and individual levels.
- Flexible management: LLCs offer greater flexibility in management structure than corporations. An LLC can be managed by the members or a manager, depending on how you want to run the business; one or the other may be more beneficial.
- Formalities: There are typically fewer formalities in terms of meetings and recordkeeping, however, it is advisable to use corporate formalities. LLCs can have one or multiple owners. Each owner's share, also known as membership interests, determines profit and loss share.
- Less paperwork: LLCs are known to have a less complex formation and filing requirements.
- Perpetual existence: Unlike sole proprietorships, which dissolve upon the owner’s death or disability, LLCs may continue to exist regardless of changes in ownership, although some states limit how long an LLC can exist without a member. Nonetheless, this provides stability and continuity for the business.
Advantages of a Corporation:
A corporation, in contrast with an LLC, is owned by the shareholders. The business is operated by officers, managed by a board of directors, and each of them have certain legal duties and liabilities. You can see how it’s more complicated already! This business structure is often selected when businesses want to raise money, gain venture capital, and plan to go public, and/or be sold.
- Limited personal liability: Similar to an LLC, shareholders in a corporation are not personally liable for business debts and liabilities. This protects their personal assets from creditors and legal claims against the corporation.
- Ability to raise capital and access to public markets: Corporations can issue shares of stock to raise capital from investors. Corporations can list their shares on public stock exchanges, allowing them to raise even larger amounts of capital and increase their visibility and liquidity. Corporations have no inherent restrictions on their size or growth potential. Corporations may be able to offer competitive benefits packages and stock options, making them more attractive to talented employees.
- Perpetual existence: Like an LLC, a corporation has perpetual existence and continues to exist regardless of changes in ownership or management.
- Ownership transfer: Ownership in a corporation can be more easily transferred by selling shares of stock, making it attractive to investors and facilitating succession planning.
- Stronger governance: Corporations have a defined governance structure with a board of directors and officers, which can provide greater accountability and oversight compared to other business structures.
Regulations and governance requirements can be more rigid for corporations than other business structures and there is increased complexity and costs associated with formation, compliance, and reporting requirements.
Please note, effective January 1, 2024, in compliance with the Corporate Transparency Act, many U.S. corporate entities (including LLCs) will be required to report their ownership information to the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN). Read the Adams and Reese client alert. Fines for non-compliance can be mission critical.
Conclusion and Additional Factors to Consider
Do not “gun deck” your business formation. Gun decking – military vernacular for fabricating or falsifying – will often lead to issues and more money spent down the line. The best way to properly form and file your business structure is to do all the heavy lifting on the front end.
Hiring an attorney or financial professional can help you think through all the eventualities, possibilities, conflicts, liabilities, and “what if” scenarios. Envision what you want to do before you form; that’s very important. Spending the appropriate time and capital upfront will save you money, frustration, and headaches in the long run. The laws and regulations governing businesses can vary depending on your location. It is important to consult with an attorney to ensure that you are in compliance with all applicable laws.
Many would-be business owners turn to third-party products or even nowadays, artificial intelligence programs, to draft company ownership agreements and bylaws when forming a business. But remember, your formation documents are like the birth certificate of your company; they need to be specific and tailored to your business needs, properly outlining all the responsibilities to ensure you are protected.
We look forward to continuing to provide hot topics of corporate and legal interest that can help military veterans transition back to society and launch their new business careers.
For Our Veterans, by Our Veterans - Adams and Reese is proud to feature a series of informative articles addressing hot topics of legal interest for service members transitioning back to the private sector. Sean Buckley, a veteran U.S. Navy Officer, is a corporate services attorney in the Houston office. John Woods, a former infantry officer in the U.S. Army National Guard, is a litigation attorney in the Memphis office.