From sole proprietors and partnerships to LLCs and S corps, the legal entity you choose for your business should provide your person with reasonable protection against financial and legal challenges, but understanding which entity to form for your organization can be complicated, and so can the paperwork that goes along with it, but it doesn’t have to be that way. Connecticut-based attorney Diana Bartolotta advises select small business owners, real estate developers and entrepreneurs on the differences between each of the corporate entities that are out there, the tax advantages of each — if any — and which entity may be right for their particular organization.
The type of entity that you choose should relate to your personal goals, your business needs, and your risk, and it's not so much the perception.
- Diana Bartolotta
Anyone who owns a business at one time or another will have to consider what many businesses believe is a necessity, what really many business owners believe is a necessity, and that's incorporating, or forming what the government calls a legal entity. Now, on this edition of Deal Talk our guest expert will discuss the subject of entity formation and why it's so important in our competitive business world. Her name is Diana Bartolotta. She's an attorney and founder of DLB Consulting. Ms. Bartolotta provides consulting and legal services to select small businesses, real estate developers, and entrepreneurs. Diana welcome to Deal Talk. It's good to have you.
Diana: Thank you. It's great to be here.
Jeff: Are we in a day and age, Diana, do you believe that, it's just seeing capitalism is just alive and well, thriving all over the world it seems. The developing nations are quickly becoming fully developed economic powerhouses. Are we in a day and age where forming a legal entity for your business is really no longer an option but a necessity?
Diana: I would say yes. If you're going to be conducting business you want to make sure that you're protected personally. And so if you don't create an entity structure and you're operating on your own, if you were to be sued you'd be sued personally. Whereas if you have an LLC or you have a corporation, you're conducting business and you're sued, in the nature of that, a breach of contract, something like, your entity will be sued and not you individually. So this protects your assets, your house. It kind of separates your personal life from your personal life. The other part of that is it's a lot of easier to form a business than it used to be. There are a lot of self-help resources online. LegalZoom is a great resource for creating your own entity. Rocket Lawyer is another one, oDesk, Guru, there's so many platforms out there that it's really a lot easier to navigate than it used to be.
Jeff: Here's a dumb question. Really, I think this might be kind of an ignorantquestion but I have a feeling there might be one or two other people out there ignorant like the host who might have this question too. In this day and age, and again I say in this day and age, with so many frivolous lawsuits that are filed out there, doesn't the government offer us any protection, or doesn't the law maybe from state to state offer individuals protection from frivolous kinds of cases when it comes to transacting business. And particularly when we're not talking about high dollar propositions, maybe a business of maybe only a hundred dollars or two, or a few hundred dollars purchase where the individual owner, a sole proprietor, or an independent contractor, or a freelancer is protected from these really large impactful lawsuits that really can damage someone personally for a very, very long time.
Diana: I think there's two parts to answer your question. One is in terms of frivolous lawsuits there are a lot of protections in place. One being if someone brings a frivolous lawsuit against you, you can ask to have that dismissed and you canalso say to the judge, “I'd like my attorney's fees covered” because it can cost you a lot of money to defend yourself against a lawsuit that had no merit. And so a judge can award you attorney's fees which means that the person that brought the lawsuit that had no merit has to pay for the cost to you. So that's one of the prohibitions in there. Another is that the attorney who brings a frivolous lawsuit can actually be sanctioned. And so attorneys really are held to thisprofessional conduct standards. It's roughly the same in every state. And if you bring forth frivolous lawsuit you can be sanctioned by the bar, and that’s a pretty big deal togo through. So on that, protection from frivolous lawsuits, there are a lot more protections there that I think the media would portray because we hear about these crazy lawsuits.
The second part is you asked if there were protections in the law to protect the little guy from this. And I would say personally, no. The way that it's built-in is the creation of these entities. Creating a corporation, creating a limited liability company, this limits your personal exposure. So that's really the mechanism that's created in the law to protect you. The law is saying, "Hey, setup a separate entity and we won't put you at risk here. We'll recognize your efforts are going towards putting a business together.”
The way that it's built-in is the creation of these entities. Creating a corporation, creating a limited liability company, this limits your personal exposure. So that's really the mechanism that's created in the law to protect you. The law is saying, "Hey, setup a separate entity and we won't put you at risk here. We'll recognize your efforts are going towards putting a business together."
Jeff: We're going to drill down specifically into LLC's and corporations here in just a moment, but looking down the line, Diana, from a value perspective, is there an advantage to being incorporated or an LLC when it comes time to selling your business or merging with another company in terms of the value of the very worth that it can contribute to a company? Is there definitely an advantage there?
Diana: That's a great question and that's a question that I get a lot from clients who are looking to form their companies. There is a perception that corporations are more credible. I wouldn't say that it necessarily factors into the valuation, because when we go to sell a business typically you don't actually buy that legal entity, you form your new entity and you buy all the assets of that business and we can talk if you'd like about why you do that. And so if you're buying a company and the company that you're buying is set-up as an LLC or set-up as a corporation, you don't have to set it up the same way, you can set-up your entity the way you want to, buy the assets, and do business that way. But there is kind of a perception and a concern that I get from business owners that if they are merely an LLC it doesn't have that level of professionalism that corporations do. But as an attorney I don't really think that play out. The type of entity that you choose should relate to your personal goals, your business needs, and your risk, and it's not so much the perception.
Jeff: Attorney Diana Bartolotta from DLB Consulting is our guest today on Deal Talk. Diana, several years ago it seemed that the list of LLC filings was going by the second. You can literally hear that list grow. Is that still true today as LLC? That's still really kind of the sexy entity, is that correct?
Diana: Yeah, I would say so. And there’s lots of reasons for that. LLC's have only been around for about 25, 30 years or so. Before that we had corporations and they were broken into S Corps and C Corps which still exist. And so the mom and pop shop would be an S Corp because it's a closely held corporation. They were created in the eyes of the law to allow for the smaller type of business. And then eventually the LLC came around and said, "Let's make it even simpler." The LLC provides that protection in a simple way. And so I would say that more people head in the direction of an LLC currently that corporations in terms of just number of startups. But there are special circumstances where a corporation makes a lot more sense. But an LLC is easier to file, it's easier to maintain, there's less formalities, it's easier to navigate that paperwork. You don't need by laws, in corporations you need by laws. There's just an extra level, things are a little more difficult to maintain. But I'm sure many listeners out there have S Corps that they’ve had for 25 years and they're saying to themselves, "You know Diana, you're wrong. It's not a big deal. Maintaining my S Corp is not that hard." But when you're starting as a new person and you've never done this before the LLC generally has smaller requirements. It's just easier to do.
The LLC provides that protection in a simple way. And so I would say that more people head in the direction of an LLC currently that corporations in terms of just number of startups. But there are special circumstances where a corporation makes a lot more sense. But an LLC is easier to file, it's easier to maintain, there's less formalities, it's easier to navigate that paperwork. You don't need by laws, in corporations you need by laws. There's just an extra level, things are a little more difficult to maintain.
Jeff: How long typically does it take from the time that you kind of start to work toward gathering all the information, completing the documentation, the submittal process, and then getting an approval before you can get that official entity status?
Diana: That's a great question and that's another question I get a lot. It's actually really fast. It’s state-specific. Every state is different so I'll give you some examples:inConnecticut where I’mlicensedI can form a corporation or an LLC same day. I can do it online on the Secretary of State's database, or … same way. There are a lot of states that are like this. Pretty much every state is online and you can do it directly through the Secretary of State database. But then there are certain states that have additional requirements. For instance I'm creating a corporation for a client in Pennsylvania. And part of Pennsylvania's requirement is that we file a notice in the newspaper for corporations. In New York if you form an LLC you also need to file a notice in the newspaper. The registration with the state can be done in a matter of minutes. If there are notice requirements that can take a couple of weeks. Pennsylvania requires that you put your ad in for two weeks. I think New York is two or four weeks. So there can be that startup times included.
Jeff: And I think those newspaper requirements actually are fairly common across the United States. I know that California I think is the same way as a matter of fact. I could be wrong about that but we all kind of wonder what's going to happen when the newspapers go away? And there's that very real possibility. That's another program. We'll talk about that another time.
Jeff: Yeah. It seems to me I read something somewhere that there is a kind of LLC for single individuals, for example sole proprietors. Is there something like that that's available or am I wrong about that, Diana?
Diana: That's a great question too. You can own an LLC as one person in any state. However, states have handled sole member LLC's differently in terms of law suits and what we call “piercing the corporate veil.” So piercing the corporate veil is what you do when you want to remove that shield and sue the person personally. Because LLC's have lower formalities a lot of times with asolemember LLC the person gets kind of sloppy with paperwork,they're mingling their personal funds with the business funds. Really that business is no different from them personally. And so when they're sued the plaintiff’s attorney is going to say,“This person wasn't acting as a business, they're acting as an individual. Let's pierce that corporate veil, hold them responsible personally.” With an LLC with one owner you're more at risk for that to be allowed. With a corporation it’s a lot harder to pierce the corporate veil. With an LLC with more than one owner it's a little harder to pierce the corporate veil. States like Florida, a lot of people who are forming solemember LLC's in Florida are saying, “You know what, I feel nervous here because the recent court decisions” and they're adding in second members there. For example a husband and wife team arestarting a business,the wife's going to do most of the work. We're going to include the husband in that LLC because it's a lot harder to pierce that corporate veil with thatextra person there.
With a corporation it’s a lot harder to pierce the corporate veil. With an LLC with more than one owner it's a little harder to pierce the corporate veil
Jeff: What does a company have to do to keep the status of their entity valid and in good standing. It's not just one of these things where you file and you set it and forget it, there's some maintenance involved here, right?
Diana: Greatquestion. Most states require an annual report, although I was just working on one inanother state, I think it might have been Virginia orMaryland, where their report was every three years. For an LLC, typically the Secretary of State says,“I want you to file an annual report every year” and that sounds scary to small business owners who’ve never done this before. It's really just you signing a piece of paper, sending in a fee that has your mailing address and that you're currently in business. And then that way the Secretary of State can maintain all the listings as active when they get that paperwork back and they don't have to track people down. Once a year you'll fill out that report and pay a fee; at the low end it might be once every three years.
Jeff: Entity formation, options, upkeep, and what you need to know to stay compliant with attorney and founder of DLB Consulting Group Diana Bartolotta. My name is Jeff Allen and we'll continue our chat when Deal Talk returns after this.
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Jeff: Welcome back to Deal Talk, I'm Jeff Allen with Attorney Diana Bartolotta of B-Law and founder of DLB Consulting Group. Diana, I appreciate having you on board today because this is really a great conversation that we're having, and I think for some people and particularly for sole proprietors, or entrepreneurs, start-ups, this is one of those conversations that we really need to share with them because it really is important to give some consideration to incorporating or at least forming an LLC to provide you with some personal protection in the event that an unfortunate situation should arise where attorneys get involved and come after you for whatever reason. Hopefully that doesn't happen, but this is the kind of thing that protects companies and organizations, and really allows them to maintain a level of compliance that they may not be able to have right now independently as a freelancer or sole proprietor. So I really appreciate having you giving us some great valuable information here. What are some of the common issues that may impact the validity of an entity, Diana, in your view?
Diana: That's a great question. When we're looking at deals, so we're talking Deal Talk today, mergers and acquisitions, the sale of a business. When we're talking about these kinds of transactions we always want to look at the authority. We want to look at does this entity have the authority to do what it's doing. And that's where the lawyers come in because we have our checklist and we look through everything. Authority seems kind of silly when you own your own business, right? Of course I have the authority to do this. But what gives you the authority? If you own an LLC you're the owner, you have the authority to transact normal business. You might have an operating agreement for your LLC that spells out what each owner, each member has the right to do. If you're a corporation you have additional formalities. You're going to have a resolution. So if you want to sell your business you would have to make sure that you went through those steps and that you properly gave authority for what you're trying to do.
We want to look at does this entity have the authority to do what it's doing. And that's where the lawyers come in because we have our checklist and we look through everything. Authority seems kind of silly when you own your own business, right? Of course I have the authority to do this. But what gives you the authority? If you own an LLC you're the owner, you have the authority to transact normal business
Jeff: My next question though is kind of taking a step over. Let's say you're a business owner and you've just become aware of an issue. This may even be something that is discovered perhaps by an attorney representing someone that you're trying to possibly sell your business to, and you're out of compliance. What steps should a company take to remedy the situation and how quickly can a company solve these issues and regain that compliance?
Diana: That's a great question and that's a lot of fear that sellers have if they've never done this before. Just know that in every closing and every transaction there's always something that comes up that we solve behind the scenes. If your LLC registrations lapsed because you didn't file the annual report last year it's not the end of the world. We just a pay fee, we fillout somepaperwork, it can be done very quickly. Some things can delay it. For instance I was updating aclient's information on their LLC which was filed in a couple of states on the east coast. And we have to request paper copies of the paperwork from the Secretary of State's office which had to mailed to be in Oregon. And then I had to fill them out and send them to the Secretary of State's office. It's not as difficulty in terms of what needs to get done but in terms of the timing. It can really slow down a transaction, and that can sometimes make the buyer nervous ifit takes a long time. But if the buyer's attorney and the seller's attorney have a good relationship which typically they do, that's why I like this work, it's a good kind of law, we're working together.Then we can solve these kinds of problems and we'll call the other person and say, "Hey, did you know the LLC lapsed. We got to fix this." And we'll just help each other out. So all of these obstacles are fixable. They're not as scary as it seems, but it can make the deal take longer.
Jeff: How much does it cost, Diana? I guess it's probably different for all companies. Businesses are like people, they come in all different kinds of shapes and sizes, and they do a lot of different things. But is the cost really dependent on the size of the company, the size of the business, number of employees, revenue? Tell us just a little bit about what factors in the cost of forming a legal entity, and the kind of money that people could expect to pay when they go in to do this.
Diana: Great question. It's actually a lot more affordable than people think. Really if you use an attorney then you'll have the attorney's fee, thefiling fees with the Secretary of State, on the low end for an LLC or a corporation, the lower end fees are going to be $50, $100. Filing a corporation can sometimes be a few hundred dollars. And the other part is that, this is another feature of corporations. Some states have a tax on the number of outstanding shares and the valuation of the company. So you want to be really careful when you're forming that corporation in terms of the number of shares that you issue and what you put that valuation as because many states have that tax, whereas an LLC doesn't have a tax on valuation.
So your listeners probably want a dollar range. I would say if you are a mom and pop, you're just going to have a business where you're maybe going to walk some dogs or just some simple service business. You can probably file that online, yourself as an LLC. I really like LegalZoom. They have really nice software, they ask good questions, it's come a long way in the time that they've been up. And so you can form that LLC yourself through LegalZoom. And I want to say they charge a few hundred dollars, maybe $200. If you were to hire an attorney like me to form an LLC it might cost you $500 plusthe filing fees; a corporation might cost you a bit more. When I'm talking to my clients and I'm doing an intake I always try to ask what we're trying to do here. Sometimes the clients wants to do certain parts themselves. Sometimes clients need more help on the planning end and that can drive up the cost. If they just come to me and say, "I need an LLC filed in Delaware. Here are my members. I need an operating agreement" and they really have that checklist in place, I can do it for a lower cost. But if they have a lot of questions about what's the proper set-up? Do I need more than one entity? Who should be involved? How should we structure this? Then we start paying for the planning. And you want it done right but you're going to pay for the attorney's time to help you out with that planning.
Filing a corporation can sometimes be a few hundred dollars. And the other part is that, this is another feature of corporations. Some states have a tax on the number of outstanding shares and the valuation of the company. So you want to be really careful when you're forming that corporation in terms of the number of shares that you issue and what you put that valuation as because many states have that tax, whereas an LLC doesn't have a tax on valuation.
Jeff: That is really useful information because I think that a lot of people are probably scared into thinking this is going to cost several thousand dollars to do this. It's going to take me two or three years before we can take in and I've got to worry about that and running my business on top of all that. And certainly as you've pointed out that's not true, you just need to do some simple information. And if you're able to use the tools online that are available now at everyone's disposal, do so. But then people like Diana here are available to you as well. Why do corporations, Diana, sometimes convert over two LLC's? We've seen this before. And I'm wondering do LLC's, do you often have limited liability companies that come in and want to incorporate as well, maybe as an S Corp?
Diana: That's a great question. It's actually more common to see an LLC switch to a corporation than the other way around.
Jeff: Is that just because they get bigger? Is that what it is?
Diana: Well, there's a couple of things that happen. An LLC might change to a corporation for a couple of reasons. One is they prefer a corporate structure. And I want to put a little asterisk here and a little side note, as an LLC you'll be treated as a corporation for tax purposes. So this is a great, little secret where you can have the LLC structure, it's nice and simple, it's easy for you to maintain, you don't have those by laws, you don't have the additional formalities, but you still get taxed as a corporation which allows your accountant to maximize some tax benefits there. So the most common reason would be an LLC wants to have a corporate structure for tax purposes. There's some fun things that accountants can do to move things around and just really use your assets to benefit you. People who are doing real estate investing, I do a lot of real estate investing clients and I have a number of them who've converted from LLC's to corporations because their accountants are finding ways where they can use those real estate assets in a more advantageous way as a corporation than an LLC. So they might convert for that reason.
And then I think the most common reason that an LLC would convert to a corporation is that it's not necessarily the size because there's a misunderstanding that big companies, they're corporations, and little companies, they're LLC's. And that's not really true but it's close. Once they get to a certain level where they say, "We need expansion capital here. We're looking to venture capitalists. We want to give out equity." The people who are venture capitalists who have private money and they're looking to invest in companies, they typically would rather see a corporate structure. Because as an investor that's an easier situation for them, it's easier for them to manage, there’s different kinds of riskthere. Let's say that your company got off the ground as an LLC, things are going really well. Somebody approaches you and says, "I think your business is wonderful. I want to invest $5 million in your business. Really get this going." At that point you might consider a corporation, and that investor might want a corporation because we're looking at that size. The third reason would be if your company ever wanted to go public you would need to be a corporation. You can't sell shares of an LLC on the stock exchange. So if you want to go that route and have your big company there, and it's going to be a household name, you're going to be the next eBay, you're probably not going to be an LLC, you're going to be a C Corp.
Jeff: We've got about 60 seconds left, Diana. If there were two or three pieces of take away advice or key points from our conversation today that you'd like to go ahead and leave listeners with to kind of ruminate on what would those be?
Diana: I think the first is, it is not as expensive or too difficult to form a company as you think it is. And so it can be very scary. Just like you said, you think it's going to take all this time and all this money. It's actually a lot more affordable and the benefit that you get from that is huge. And the second reason is just in terms of business planning, really be thinking about where is your business headed, what is your exit strategy. When you're forming your entity many business owner's come to meand say, "I don't know if I need an LLC or a corporation. I don't know how I should set this up." I get a lot of clients who are entrepreneurs and have multiple businesses, and they want to keepthem all together. . Are you looking at a business where you want to pass it on to your family, maybe an S Corp, maybe an LLC. So not just the type of business that you have but how you want the business to wrap up or end would be a good question to ask yourself when you're trying to figure out the best entity structure.
It's actually a lot more affordable and the benefit that you get from that is huge. And the second reason is just in terms of business planning, really be thinking about where is your business headed, what is your exit strategy.
Jeff: Diana Bartolotta has two things that she does. She runs her own law firm, B-Law, you can look it up online. And also too she consults with businesses as well. But Diana, what I'd like to do is give you the opportunity to tell people how they can get in touch with you if they've got any questions or if there's something that you can do to help them.
Diana: Thank you. You could find me online at b-law.com, that's my law firm. If you Google my name, if you can spell Diana Bartolotta, you'll find me there. I'm all over the internet and I'm all over social media. A good way to find me would be LinkedIn, my website, B-Law is also on Facebook. In terms of helping people,yes,definitely give me a call, if you need some help with your entity formation or planning I'm happy to help.
Jeff: I have a feeling that we'll probably have some questions for you at a later time, Diana, where we can have you back on again, and I hope that you'll be open to joining us.
Diana: I think that would be great. I would love to talk more about the process of selling a business and the concerns that people should look for, and things like that. I think that would be a lot of fun.
Jeff: We'll make that a date and we're going to make sure that we jot it down in our calendar to get back in touch with you to talk about that very subject. On this note though we've run out of time for this edition. Thanks so much for joining us. We really did enjoy talking with you.
Diana: Thanks Jeff.
Jeff: Diana Bartolotta, attorney at B-Law and founder of DLB Consulting.
Deal Talk is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you'd like more information about buying or selling a business call Morgan & Westfield at 888-693-7834 or visit morganandwestfield.com. And make it a point to check in with us again soon for valuable information and insight from our growing list of small business experts right here on Deal Talk. My name is Jeff Allen.