Bob and James have been friends since high school. They decide to start a business (B&J Property Management) to acquire residential structures, fix them up, and then sell or rent them.
They used some of their retirement money to capitalize the business. Bob put up $100,000 and James put up $80,000 for a total of $180,000. However, both men agreed that each one would have equal authority to manage and operate the business. They acquired six properties for $30,000 each.
Without any formal or informal written agreement, they purchased the properties in the name of B&J Property Management and operated as a business for nine months. They leased an office, bought office furniture, opened a bank account, and obtained printed stationery.
James’ sister Lisa moved into one of the homes. Lisa had not paid her rent for the last six months. Bob initiated eviction proceedings by sending Lisa notice to vacate the premises within ten days, as required by the lease. James challenged Bob’s authority to file the eviction without his agreement. No court proceedings have yet occurred in the eviction.
Although the relationship between Bob and James is strained, Bob and James decide that they should seek legal advice on how they should structure their business as well as other outstanding legal issues. They have concluded that they should either incorporate as a corporation or form a limited liability company.
- Explain the common characteristics and differences between corporations and limited liability companies.
- Explain the advantages of corporations and the advantages of limited liability companies.
- What would you recommend to Bob and James to resolve their disagreement over whether to evict Lisa?
Structuring a Business: Corporation vs. Limited Liability Company
Bob and James, long-time friends embarking on a property management business venture, are at a crossroads in deciding how to structure their business. As they consider forming either a corporation or a limited liability company (LLC), it is crucial to understand the common characteristics and differences between these business entities, as well as the advantages associated with each option.
Common Characteristics and Differences
Corporations:
- Legal Entity: A corporation is a separate legal entity from its owners, offering limited liability protection to shareholders.
- Ownership Structure: Shareholders own the corporation through shares of stock, and it is managed by a board of directors appointed by shareholders.
- Taxation: Corporations are subject to double taxation, where profits are taxed at the corporate level and dividends are taxed at the individual shareholder level.
Limited Liability Companies (LLCs):
- Legal Entity: An LLC is a hybrid entity that combines the limited liability protection of a corporation with the operational flexibility of a partnership.
- Ownership Structure: Owners of an LLC are known as members, and they can manage the company themselves or appoint managers to do so.
- Taxation: LLCs offer pass-through taxation, where profits and losses are passed through to the members and reported on their individual tax returns.
Advantages of Corporations
Limited Liability:
- Shareholders are typically not personally liable for the debts and obligations of the corporation.
- Provides protection for personal assets in case of legal claims or financial liabilities.
Access to Capital:
- Easier to raise capital by issuing stocks and attracting investors.
- Establishes credibility and may attract more investors due to the well-defined corporate structure.
Perpetual Existence:
- Corporations have perpetual existence, meaning they can continue to operate even if ownership changes or key members leave.
Advantages of Limited Liability Companies
Limited Liability:
- Members enjoy limited liability protection similar to shareholders in a corporation.
- Personal assets of members are shielded from business debts and lawsuits.
Tax Flexibility:
- Pass-through taxation allows profits and losses to flow through to members' individual tax returns, potentially reducing overall tax burden.
- Members can choose to be taxed as a partnership, an S corporation, or a sole proprietorship.
Operational Flexibility:
- Less formalities and paperwork compared to corporations, offering more flexibility in management and decision-making.
- Allows for customization of operating agreements based on specific needs and preferences of members.
Recommendation for Resolving Disagreement
To resolve the disagreement between Bob and James over evicting Lisa, it is advisable for them to seek legal counsel to address the issue within the framework of their business structure. Regardless of whether they choose to incorporate as a corporation or form an LLC, establishing clear guidelines and procedures for decision-making in their operating agreement is essential.
Given their equal authority to manage the business, Bob and James should work together to develop a consensus on significant decisions like evicting tenants. They may consider incorporating provisions in their operating agreement that outline dispute resolution mechanisms and decision-making processes for handling such situations.
In conclusion,
while both corporations and LLCs offer distinct benefits, Bob and James must carefully evaluate their business goals, risk tolerance, and management preferences to determine which entity best suits their needs. By seeking legal advice and fostering open communication, they can effectively navigate challenges and ensure the success of their property management business venture.