Let’s talk a little bit now about the governance of the business entity and how the business entity is structured.
Traditional C Corporations
Traditional C corporations have well-defined structural accountability, with governance responsibilities that are held separate and apart from the owners. Management is typically accountable to a board of directors, and as a result, it has the ability to transact its business without stockholder participation in each decision. So there’s a lot of flexibility with the corporation, and the board of directors typically doesn’t have to go to its stockholder base to get their approval for every routine daily decision. It’s really the more important decisions that require stockholder approval in a corporation.
That being said, corporations are required to pay attention to formalities that state legislatures and courts have determined to be significant. For example, corporations typically need to have the board of directors meet on a fairly regular basis or at least an annual basis. The directors have to adopt corporate bylaws, which govern the day-to-day operations of the business. Corporations also have to maintain corporate minute books and stock ledgers and separate bank accounts from their owners.
So you do have to be very mindful as the owner of a corporation to separate you as an owner from the corporation as a business. Failure to do so can result in what’s called the “piercing of the corporate veil,” which effectively would be a court saying that the corporation really doesn’t have any separate legal existence from its owners, and as a result they’re going to set aside the corporate form and look to the owners directly for the liabilities of the corporation. That’s really a situation you never want to be in. If you adhere to the corporate formalities that I just summarized, you should be in pretty good shape and not have to worry about that happening.
Limited Liability Companies
Let’s talk a little bit now about a limited liability company compared to a corporation. Limited liability companies are very flexible with respect to the distribution of cash and the other assets of the business and also the allocation of income and losses among the owners of the business compared to a corporation. LLCs generally operate more informally than corporations operate. They’re either managed directly by all of the owners or they’re managed by one or more specified owners or an outside party who serves as a manager that’s specifically designated to fulfill such responsibilities.
In certain states, let’s use Delaware for an example, an LLC may even limit the fiduciary obligations of its managers, which is quite a difference from a corporation, where fiduciary duties are very important and pronounced. Bear in mind that’s not the case in Massachusetts, as the case law stands today in early 2017. But in Delaware, you can in your operating agreement limit the fiduciary obligations of management to the owners, which is a very important difference compared to corporations.
Limited liability companies are not bound by the same level of corporate formalities as corporations, such as holding regular ownership and management meetings, and so that creates more flexibility than you might typically find in corporations. There’s also arguably less paperwork involved with a limited liability company than with a corporation. In a limited liability company, you bundle all the provisions that are typically included in the corporation’s charters, bylaws and stockholder agreements into one operating agreement.
Even though you have less paper for a limited liability company, an operating agreement can be a fairly dense document that you have to deal with and pay a lawyer or an accountant to draft.
In contrast with corporations, limited liability companies really don’t operate under a well-defined regime of uniformity and legal precedent. If you think again about corporations, they have existed for centuries and there is a very deep and robust body of case law that documents the operations and the obligations of management to stockholders. Limited liability companies really only came into vogue in the last 40 years. We can’t, therefore, be confident about how a court will rule in respect to the operations of a limited liability corporation because we don’t have a robust body of case law to refer to. So that’s another consideration to bear in mind when you’re deciding whether your business entity should be a corporation as opposed to a limited liability company.
About Scott Bleier
Scott’s practice is focused on the representation of entrepreneurs, emerging technology companies and venture capital investors. Scott specializes in corporate and securities law; private financings; and mergers and acquisitions.
Scott has worked with technology companies and their founders in a wide array of industries, including software, e-commerce and internet, life sciences, biotechnology, retail, consumer products, manufacturing, and healthcare information and management. Scott serves as outside general counsel to his company clients, advising their boards of directors and senior management on a broad range of corporate matters, including company formation, founder equity structures, financing transactions, corporate governance responsibilities, equity-based compensation strategies, employment issues, intellectual property, and commercial transactions. Scott also regularly represents these clients in mergers and acquisitions, including a significant number of sales transactions with large, public companies.
In addition, Scott devotes a significant portion of his practice to the representation of venture capital investors, negotiating and structuring portfolio company investments on behalf of these clients.
Scott also represents established foreign companies seeking to expand their operations to the United States.
Scott speaks regularly on entrepreneurship, start-up companies and financings, delivering presentations to entrepreneurs, investors and lawyers at the Cambridge Innovation Center, Swissnex Boston, the American Bar Association and the MIT Enterprise Forum. Scott currently chairs the Venture Capital Transactional Issues sub-committee of the Business Law Section of the American Bar Association.
Scott is a frequent writer on topics involving start-up companies and corporate law. You can follow Scott on Twitter at @bleierlaw.