Now we’re going to talk a little bit about the ownership of the business and what some differences are between establishing a corporation and a limited liability company with respect to ownership.
The C corporation is able to have an unlimited number of stockholders subject to FCC reporting requirements if the number of stockholders exceeds 500. Conversely, S corporations are limited to 100 stockholders, and all of those stockholders have to be natural persons. In other words, you can’t have any entity investors. There are some limited exceptions for certain types of trusts, estates, and exempt organizations, but generally speaking, you can’t be an entity to be a stockholder of an S corporation. Also very importantly, all stockholders also have to be U.S. citizens or resident aliens of the United States.
Generally speaking, with a corporation, stockholders don’t have to have a relationship with one another, nor do they need to have a role in running the day-to-day affairs of the company. They can be passive owners and allow management or the board of directors to do that. Additionally, subject to any contractual arrangements to the contrary, stockholders of a corporation are able to transfer their ownership in the corporation freely and readily by selling their shares of stock, and they can do that without affecting the continuing existence of the business or the title to its assets. In other words, the perpetual existence of the entity is unaffected by the death or withdrawal of any one stockholder.
Limited liability companies are similar to a C corporation in that an LLC can have an unlimited number of owners, typically called members in the LLC context. Unlike an S corporation, entities and non-U.S. citizens or resident aliens may be owners of an interest in the LLC. That’s an important difference between an S corporation and a limited liability company.
However, an important difference between a limited liability company and a corporation from an ownership perspective is that the transferrability of ownership interests for an LLC are typically not as flexible. Typically, a member of a limited liability company needs the approval of the other members before selling an interest in the LLC. And this is really a vestige of the history of how LLCs came to be in the first place. LLCs are really hybrids between partnerships and corporations. If you think of a partnership, you think of people who are closely related or involved with one another rather than the relative anonymity of a corporation. Because of that, it’s a bit of a vestige of the ancestry of an LLC. Typically speaking, it’s a little more difficult to transfer ownership interest in an LLC compared to a corporation.
In addition, a death, withdrawal, expulsion, or other departure of a member from an LLC can oftentimes constitute a termination of the LLC itself and/or it could also constitute a deemed liquidation for federal tax purposes. Unlike a corporation, the perpetual existence of the LLC as a business entity may be affected by the death or withdrawal of just one member. That’s an important difference to bear in mind when you’re considering what type of business entity makes the most sense for you.
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.