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Ten Myths about Choice of Entity

Choosing a form of business entity is one of the first and most important decisions a small business owner makes. This decision can have a major impact on financing, management, and compliance obligations. Yet, myths abound about various business options. The information below can help clear up some of the popular misconceptions about the various forms of entities that can lead to ill-advised decisions.

MYTH: Corporations are the only type of entity that can be publicly traded.

REALITY: Limited liability companies (LLCs) can be publicly traded—as can limited partnerships (LP), and other entities too.

CT Tip: Ensuring that non-corporate entities are structured so that they can be publicly traded requires expert advice and carefully drafted documents, so make sure to work with your attorney if you plan to go public.

MYTH: Corporate shareholders and LLC members are free to sell their stock/membership interests without having to get the other shareholders or members consent.

REALITY: It’s true that corporate shareholders can freely sell their interests—unless the bylaws or another agreement limits this right. But, with an LLC, this is reversed. LLC members must get consent from the other members—unless their operating agreement provides that they don’t have to.

MYTH: Only human beings (as opposed to business entities) can act as corporate directors, LLC managers, or general partners.

REALITY: Only human beings can be corporate directors. However, business entities can be managers and general partners.

MYTH: LLCs and partnerships are “pass-through” entities for federal income tax purposes. A corporation is not.

REALITY: By default, a corporation is not a pass-through entity: It must file its own tax return and pay taxes on its taxable income. But, if a corporation qualifies for S corporation status and makes the required election, it can be a pass-through entity as well.

MYTH: A benefit corporation is a type of nonprofit corporation.

REALITY: A benefit corporation is a for-profit corporation.

CT Tip: A benefit corporation is a relatively new kind of for-profit corporation. Unlike a traditional corporation that must operate solely to maximize value to its shareholders, a benefit corporation is required to balance shareholder interests with a clearly stated social mission.

MYTH: Corporations and LLCs are required by statute to hold organizational meetings after filing the formation document in order to complete the organization of the corporation or LLC.

REALITY: Corporations are required by statute to hold an organizational meeting.  LLCs are not.

MYTH: The doctrine of “piercing the veil” - under which a court holds an entity’s owner liable for the entity’s debts - applies to corporations but not LLCs.

REALITY: Courts have pierced an LLC’s veil to hold its members’ liable also.

MYTH: A limited liability company is always the best choice for a small business

REALITY: As these myths all reveal, the best choice for a business depends upon many factors.  They include, but are not limited to: the type of management and control desired, the funding options that might be pursued, and tax consequences for the owners and the business. There is no one-size-fits-all business entity.

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