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Ownership v. Control v. Income ... Selecting a Business Entity ...

Posted by Giselle Ayala Mateus | Feb 13, 2021 | 0 Comments

When it comes to selecting a business entity to take your enterprise to the next level, it is essential to understand those key factors that make the difference and ownership only one of them. Control, governance structure, transferability, and income potential are some of the most important factors you consider before choosing between LLC, Corporation, Partnership, or any other business structure. 

Control 

It is important to understand that there are some legal entities that limit the owner's control and management more than others. This is important because those who manage the organization make important decisions such as the distribution of profits, the purchase of machinery, or any other decisions related to the business's day-to-day activities.

In general terms, partnership, limited or unlimited, allows owners to control and manage the business. Limited partnerships have a particularity; there are two types of owners. An unlimited partner, who responds personally for all liabilities and obligations acquires as a result of carrying on the business, and limited partners who contribute money or other assets, who do not get involved with the management of the business, and whose responsibility extends only to amount of their contribution to the partnership.  If a limited partner gets involved in the management of the business he no longer enjoys the benefit of limited liability. 

Corporations do not allow owners to manage the business's day-to-day activities unless they are elected as directors or corporate officers. On the other hand, LLCs allow the owners or "members" to select whether they want to manage the business themselves or whether they want to elect managers to handle the business. 

Governance Structure 

Governance structure speaks of the number of people and the roles needed in the organization to manage it properly. The more complex the governance structure is, the more costs and time a business requires. 

Partnerships require only two or more people to join efforts to carry on a business as co-owners. However, more complex business entities, such as corporations, require a more complex structure. 

Corporations cannot be managed by their owners unless they are elected as directors or officers. A board of directors manages the corporation. Of course, a corporation can be an entity with only one owner. In that case, the sole shareholder occupies all positions.  Nevertheless, even that single owner must demonstrate that corporate formalities are followed to handle the business for purposes of compliance. Corporate formalities are important, especially to keep the "corporate veil," in other words, to keep the benefit of the limited liability. 

LLCs can be managed by their members (Member-Managed LLC) or by one or more managers (Manager-Managed LLC). In either case, the formalities are important to keep the protections of the "corporate veil". 

Income

You may think that by owning a business, you will automatically receive income from it. Well, it may not be as simple as that. In the case of a business owner who does not incorporate, in other words, who does not form a legal entity, that business owner receives income directly from his customers. However, when a legal entity is created, or the business owner is in partnership with another, the situation changes. 

Partners share equally in the monetary benefits of the business unless there is an agreement to the contrary. Unlike other legal forms, when it comes to partnerships, income is distributed equally regardless of the amount of the contributions made by each partner. In the case of limited partnerships, unless otherwise agreed to, partners share equally the income of the business, but their responsibility is different. There is one partner who personally responsible and other partners who enjoy limited liability. 

In the case of the corporations, it is important to understand that the ones who run the business and decide whether income is distributed are the member of the board of directors by vote. Directors receive compensation from the company for their role. If owners of the corporation want to receive income directly from the corporation, one way is to be a director or an employee of the corporation. Now, if the owners of the corporation, who are not employees or directors, want to receive income by way of dividend distributions, they have to wait for the directors to approve such a distribution. To deal with these, corporate shareholders select directors, at least one, who will support their interest and advocate for these distributions.   

In the case of an LLC, it all depends on the rules stated by the members of the LLC. If the LLC members agreed that a manager would make the decision of profit distributions, they should set some guidance or rule for making such a discretionary decision. On the other hand, if the LLC is member-managed, distributions of income will be decided by the members by vote, according to the percentage of interest in the LLC.

Transferability 

Another important aspect to consider is the transferability of the interest in the business. We all want to be successful in our business endeavors; however, things could go wrong; in that case, it would be great to be able to transfer your interest in the business to some else. In the case of a partnership, the concept of transferability rarely applies because partners come together in consideration of each other's personal characteristics. Additionally, since no express or written agreement is required to create a partnership, no special formality is required to end it. 

Limited partnerships must be agreed to in writing. Consequently, whether an interest in a limited partnership is transferable depends on the terms of the agreement. Usually, general partners cannot transfer their interest because they are in charge of the management, responding personally. If a partner who has management and control of the business wants to leave, unless the other partners agree to continuing with the business, the business must be dissolved.

Shareholders, owners of shares, own corporations. In general terms, the shares of a corporation are freely transferable. However, in real (practical) life, the transferability of shares also depends on the existence or not of a market for the shares. If the shareholder who wants to leave has no agreement that protects his interest or is a minority shareholder who cannot influence the decision-making process, it is unlikely that he finds a buyer for his shares. On the other hand, if the corporation is one of those who trade their share in the capital markets, such as the New York Stock Exchange, it is more likely that the shareholder who wants to leave finds a buyer.   

LLCs are a mix of different concepts. As a result of that, the transferability of a member's interest depends on the terms of the LLC agreement. There are cases in which a Member-Managed LLC has an agreement that limits the transferability of interest or states that even if a member sells his interest, the new member will not be allowed to get involved in the LLC management. 

In conclusion... before selecting a business entity, keep in mind that different factors are worth reviewing and that an attorney can help you make the right choice because she will be able to explain the terms of an agreement mean. For more information, feel to call or email. The law office will be happy to guide you and see you have success. 

About the Author

Giselle Ayala Mateus

Giselle Ayala Mateus is a NY attorney with comprehensive experience in transactional law, creative agreements, business formation, and immigration law. She is also the founder of FOCUS a not-for-profit project focused on supporting entrepreneurs and artists.

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