A Key Difference between corporations and LLCs

When you are deciding whether to set up a new corporation or a set up a new LLC, there are many to issues to consider, including who your intended investors will be, what your corporate purpose will be and the tax considerations. On the surface, the two types of entities look very similar, and from day to day there is little difference from an operating point of view.

However, there is a key fundamental difference that will affect the corporation over time: a corporation is separate from its owners while an LLC is essentially composed of its owners.

The basic power structure of a corporation is this:
• The officers are the only ones who can obligate the company; the officers are appointed by the directors, who in turn are elected by the shareholders. For a one-person company or Exxon/Mobil, the structure is the same.

• For an LLC, the members are all powerful, and can decide to delegate some or all of their powers to managers.

For a very small company, the distinction is minor, but as soon as the company grows the potential for trouble expands exponentially.

This difference becomes apparent on the day of its organizational meeting, when the directors issue the shares of the corporation to the shareholders. This is a deal between separate parties: the shareholders must buy the corporation from the company in exchange for cash and/or services, with the directors determining whether the value received is fair. Because the corporation is a separate entity from the shareholders, the shareholders then need to sign a contract with the corporation to define what they are receiving and what restrictions are placed on the purchase. Just being a shareholder does not entitle you to any of the corporation’s assets nor guarantee a voice in governing the company; nor empower you to act on behalf of the company in any way. Without a shareholder agreement that limits the ability to transfer shares to someone else, you find that another shareholder has sold their shares to someone else, and you may wind up with unwanted fellow shareholders, including those not permitted to be shareholders under security regulations and perhaps even competitors.

A limited liability company, on the other hand, is based on partnership law. Members are very powerful unless the operating agreement has taken their default powers away. In an LLC with no Managers, all the members have the right to obligate the company individually unless the operating agreement takes this ability. Even where there are Managers, their roles are defined in the operating agreement, and members may still have substantial powers to bind the company on their own. In a single member LLC, this is not important but as the company grows this can become a massive headache for the unprepared.