Choosing a Business Entity
Generally, a company may choose to be one of four entity types, a corporation, a limited liability company (LLC), a partnership, or a sole proprietorship.
LLCs are creatures of contract and are governed by an operating agreement; thus the rules governing an LLC can be very flexible. It is highly advisable to have an operating agreement drafted that is consistent with the expectations of the members, because improperly drafted operating agreements can be difficult to amend without the full and unanimous consent of the members.
Outside and institutional investors may be leery of investing in LLCs, because the rights of equity and control are based in contract, and can be as varied through creative drafting. Most statutory provisions about LLCs can be superseded by contract, meaning that a full understanding of all versions of the operating agreement, and the transactions that occurred under each version, would be important to create certainty about rights and interests. Because of the substantial research involved in knowing what arbitrary rules or financial requirements the members of the LLC can continually create for themselves, institutional investors may be wary of investing in LLCs.
In contrast to LLCs, Corporations are rigid creatures of statute, which creates increased certainty for investors. However, such rigidity also creates substantially increased operating costs. In an LLC, the operating agreement may provide for the Manager to make all decisions, but a corporation has a board of directors, which appoints officers. The officers serve at the pleasure of the board (which passes numerous resolutions), and must act in a way that is consistent with the bylaws and the articles of incorporation, all of which are approved by the board.
This means that the governance of corporations produce substantially more paperwork than an LLC, but if done correctly, corporations can lend themselves to more accountability to the shareholders. This increases the likelihood of investors being confident in funding a business.
There are benefits and costs to both LLCs and Corporations, and it is important that a business decide which entity would best suit their business needs.