I worked as an attorney in New York. Sometimes I’m asked about the various types of entities you can use when establishing a business in the United States. There are more options than in Australia. Here is a very high level overview. It describes some of the features that may determine the best choice of entity.

Delaware

Formation of business entities in the United States is largely at a state level and the most popular jurisdiction is Delaware. It has the most flexible, up-to-date and pro-business corporate laws. With a corporation, for example:

• the identity of shareholders does not need to be disclosed;
• shareholders do not need to be US citizens or even US resident (NOTE: even so, for certain classes of industries in the US there are foreign ownership restrictions);
• you can have sole director corporations;
• meetings and records can be held anywhere;
• directors can amend the by-laws (i.e. constitution) of the corporation without shareholder consent; and
• there are no minimum capital requirements.

The Delaware Court of Chancery is a specialist court for corporate law, with great expertise and precedents. There is also an efficient state administration of business entities, and there is no corporate income tax for corporations that do not transact business in the state.

Because it’s the most popular jurisdiction, I’ll focus on the Delaware laws in this summary.

Main types of business entities

The main types of business entities are shown in the diagram.

 

Offshore entities are sometimes also used as part of a structure to do business in the US.

Distinguishing features

The key differences between the different kinds of business organisation fall broadly into three categories:

• Taxation – how they’re taxed
• Liability – the liability of owners for liabilities and obligations of the entity
• Flexibility – the extent to which you can structure the entity to suit your own requirements

Let’s look at each of these a little further. Taxation

• Corporations generally have ‘double taxation’ – i.e., corporate income tax on earnings and then income tax on dividends in the hands of the recipient. Small business or ‘Subchapter S’ corporations are different. They have pass-through treatment of income (i.e., no double taxation), but there are restrictions: these corporations can only have a maximum of 75 shareholders, the shareholders must not be an LP, LLC, a corporation or non-resident alien, and there can only be one class of stock. Because of the foreign ownership restriction, the Subchapter S corporation usually won’t work for a foreign investor.
• LLCs are subject to ‘check the box’ regulations, under which you can choose pass-through or double taxation. If you fail to choose, the default option is pass-through.
• Partnerships (LPs, LLPs, LLLPs and general partnerships) are pass-through entities and are not separately liable for income tax.
• Statutory trusts can be set up to be taxed like a corporation or pass-through like a partnership (or taxed as a grantor trust).
• Offshore enities formed in low-tax or no-tax jurisdictions are sometimes used by businesses operating in the US (and elsewhere), mainly for tax reasons, but there can be many complications in obtaining those tax advantages.

Liability

• Corporations have limited liability of shareholders for the obligations and liabilities of the corporation. There are exceptions of course: what is known as ‘piercing of the corporate veil’.
• LLCs also have limited liability, like corporations: the members are not liable for the obligations and liabilities of the LLC. So they offer the advantages of pass-through income for tax purposes, unlike a corporation, while maintaining the benefits of limited liability.
• With an LLP, the partners are not personally liable for obligations and liabilities of the LLP. A general partnership can be converted to an LLP to achieve this result.
• LPs have limited partners and general partners. The limited partners are not personally liable for obligations and liabilities of the LP beyond their contribution (but can be if they participate in the control of the business); the general partners will be personally liable for the obligations and liabilities of the LP. In some states (including Delaware), an LP can convert to an LLLP, under which the general partner’s liability is also limited.
• General partnerships have unlimited liability of partners, who are each jointly and severally liable for the debts and obligations of the partnership.
• The beneficiaries of a statutory trust have the same limitation of personal liability as a shareholder of a corporation, and the property of the trust is not available to creditors of a beneficiary. The trust is a separate legal entity and can have perpetual existence, except as otherwise provided by the governing instrument of the trust (usually called the trust agreement). The liability of the trustee is determined by the governing instrument, so it can be more restricted than would otherwise apply at common law. The statutory trust can also indemnify the trustee, beneficial owner or anyone else from liability, where permitted by the governing instrument.
• A joint venture is a similar type of arrangement to a partnership, but the general concept of a JV is to avoid the joint and several liability of a partnership. The rights and liabilities of the joint venture parties are determined by the joint venture agreement, and so the joint venture agreement will normally allocate and limit respective liabilities.
• Sole proprietors, of course, have unlimited liability.

Flexibility

• The corporation is probably the least flexible form of business entity. There are a lot of statutory provisions about structure. For that reason it is the preferred form for public offerings of securities. The corporation must have a certificate of incorporation and by-laws, and be governed by a board unless it is classified as a ‘close corporation.’
• An LLC is more like a partnership in terms of its flexibility. But it can have a sole member, which is something a partnership can’t (by definition). Unlike a corporation, it doesn’t need to have a board (although some do), and profits don’t have to be distributed in proportion to ownership as occurs with a corporation. The governing document of an LLC is usually called its operating agreement or limited liability company agreement.
• A partnership will have a partnership agreement as its governing document. If it is an LP, LLP or LLLP, the agreement can limit the liability of partners. And a joint venture will have a joint venture agreement, which can limit the respective liabilities of the joint venturers.
• Statutory trusts are also very flexible. There are the basic concepts of trustee and beneficiary, but their respective rights and liabilities have a potentially wide range of variation, as set out in the trust agreement.

Multi-entity structures The best form for a business may involve multiple entities, and there is an endless variety of combinations. Often businesses are structured with separate entities for separate lines of business. Another common structure is to have a holding company at the top with the corporate group consolidated for tax purposes. Sometimes entities in the chain are located offshore. Delaware business entity laws online For more details, you can access the Delaware laws on business entities online.

• Corporations - Delaware General Corporation Law
• LLCs – Delaware Limited Liability Company Act
• LPs and LLLPs – Delaware Revised Uniform Limited Partnership Act
• LLPs and general partnerships – Delaware Revised Uniform Partnership Act
• Statutory trusts – Delaware Statutory Trust Act

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Posted 28th February 2010 by Patrick Dwyer in Investments and Funds