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Five Reasons Not to Form a Corporation (and One Reason to Ignore Those Five)

On Behalf of | Apr 6, 2023 | Business Law

Today, LLCs are ubiquitous. Even the least business-savvy person will recognize that most companies with whom they deal are limited liability companies, and not corporations.

I have heard lawyers say, “It’s malpractice to use a corporation nowadays.” While that phrase might be hyperbole, the purpose of this article is to explain why, in 2022, an LLC is superior in almost all cases when compared to a corporation.

  1. Federal securities law – “Stock” in a corporation is always a security. The blanket statement is not true of all LLC membership interests. There are instances where an LLC that doesn’t meet the Howey test for “investment contract” — and in these instances, the company could have a lessened regulatory burden.
  2. Asset protection – If you own a membership interest in an LLC, the worst that one of your creditors can do to you (with regard to the LLC interest) is to obtain a charging order — such that profits from the LLC must be paid to the creditor (and not to the debtor/member). By contrast, a creditor can outright take your corporation’s stock from you. Think about the implications of that — losing your family business because you caused a car accident.
  3. Corporate formalities – A corporation in Ohio must have meetings, minutes and bylaws. An LLC needs nothing. This saves legal fees on an annual basis. More importantly, it reduces the risk that an adverse party can pierce the corporate veil, for failure to observe corporate formalities.
  4. Series LLC option – As of January 2022, an Ohio LLC may elect “Series LLC” status, which allows the entity to erect liability silos to protect various assets or lines of business from others. This option is not available for a corporation. Read my article on Series LLCs here.
  5. Tax flexibility – An LLC is, by default, a partnership for federal tax purposes. (Some people imprecisely say an entity is “taxed as an LLC”). But an LLC can check the box to be taxed as an S-Corporation or a C-Corporation. The inverse is not true; a corporation may not elect to be taxed as a partnership.

Admittedly, none of these advantages has a “wow” factor. But taken together, these five issues should lead any practitioner to advise against a corporation. Going a step further, converting to an LLC is a good idea in most instances.

With that said, Silicone Valley is still most comfortable with the corporate form (and particularly the Delaware corporate form). If you are seeking to attract venture financing (and let’s be honest, this only applies to 1-2% of new businesses), then you might need to forego the advantages of an LLC to assume the corporate form.

Attorney Michael R. Rasor advises small and mid-sized companies, routinely assisting on business formation and LLC conversions. Reach him at [email protected].

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