Legal Alerts/3 Jun 2021
Which Entity Should You Pick when Expanding into the US?
Although expanding into the US requires a lot of research, support and careful planning, companies that do succeed enjoy major opportunities. The USA has the largest economy in the world, which means that expanding your business into the US can be a very effective and lucrative way to reach new customers, diversify risk, leverage resources, and potentially increase profits. Moreover, there are many government incentives available in the US, which makes the business environment extremely favorable.
When deciding whether to form either a limited liability company (an “LLC”) or a corporation in the US, it is important to consider several factors. Some of these factors include compliance requirements, liability protection, management structure, ownership, funding options, and taxation. Below, we will walk you through the key differences between the two options so you can make the best decision for your business.
A corporation is formed by filing a Certificate of Incorporation with the Secretary of State and drafting bylaws. Corporations are required to hold an annual shareholder meeting each year and keep notes from that meeting, which are referred to as corporate minutes. In addition, a corporation is generally required to file an annual report with the Secretary of State. Any actions require a corporate resolution to be voted on at a meeting with the board of directors.
An LLC is formed by filing Articles of Organization with the Secretary of State and drafting an operating agreement. Unlike corporations, LLCs have fewer record keeping requirements. An LLC is not required to keep minutes, hold annual meetings, or have a board of directors.
The most common option for an overseas company to establish a presence in the US is to incorporate a subsidiary in Delaware. The subsidiary can be a corporation or an LLC. The Delaware Court of Chancery is focused entirely on business law, and it uses judges instead of juries, which fosters a great sense of confidence in the legal system for businesses.
Management, control and ownership
Corporations and LLCs have different management structures. In general, laws that affect corporations involve more management requirements than LLC laws do.
An LLC has a flexible management structure, which means that the entity can be managed by its members or by a group of managers, and any member may act as the LLC’s manager. In a member-managed LLC, the owners themselves oversee the running of the day-to-day operations, whereas, in a manager-managed LLC, members are investors with limited management functions and the managers manage the business and its affairs.
A corporation must have a formal structure with a Board of Directors that handles the management responsibilities of generating profits for the shareholders. Corporate officers are assigned to handle the day-to-day operations of the business, and the shareholders are considered owners of the corporation but generally remain separate from business decisions and the daily operations of the corporation. Nevertheless, shareholders have the power to elect directors.
Corporations issue shares to their owners, who are called shareholders. Corporate shares are easy to transfer from one owner to another. As such, a corporation can be a good choice for an entity that anticipates having outside investors or making a public stock offering.
The owners of an LLC are called members, and each member owns a designated percentage of the company. This is sometimes called a membership interest. Unlike shares in a corporation, membership in an LLC may be more difficult to transfer, and an LLC’s operating agreement will typically stipulate whether and how membership interests can be transferred.
Limited liability protection
Limited liability is a type of protection for one’s personal assets against the business’ debts. Corporations and LLCs are legal entities that are separate from their owners, which means that both provide limited liability protection. In other words, personal liability for the business’ debts and obligations is no more than the amount of money invested in the business.
Nonetheless, members and shareholders can still be held liable for their company’s debts under a legal concept known as piercing the corporate veil. Veil piercing is a remedy in which courts will disregard a corporate form and hold members and shareholders liable for the debts of the company.
Courts have developed various tests to decide whether to pierce the veil, but one of the most frequently used is a two-prong test. First, the court will conduct a unity of interest test, which analyses whether the corporation or LLC was undercapitalized, whether co-mingling of personal and business assets occurred, and whether there was a failure to follow compliance requirements. Then the court will establish whether the corporation or LLC was used to commit fraud.
Business growth objectives and your company’s ability to receive funding are other important aspects to take into consideration when selecting the entity that is best suited to your needs.
Corporations may obtain equity financing by selling stock in exchange for a capital contribution. Financing possibilities include common stock, preferred stock, and a variety of debt-equity hybrids. In contrast, to obtain equity investment, an LLC must make the investor a member, which generally gives the investor far more rights to control the organization than shareholders have in a corporation.
One of the major differences between corporations and LLCs is the way they are taxed.
Corporations, by default, are taxed as independent legal entities. They are responsible for paying tax on their profits and on the dividends, they distribute to their shareholders. The dividend amount is taxed at both the corporate level and personal level because shareholders also pay tax on any dividend they receive. This is referred to as double taxation.
Corporations that have 100 or fewer shareholders that are US citizens or residents and which have only one class of stock can avoid double taxation by choosing to be taxed as a pass-through business entity. Such a corporation doesn’t pay corporate income tax – its profits pass through to the shareholders’ personal tax returns, and as a result, each shareholder pays tax on their share of the profits.
An LLC is taxed as a pass-through business entity by default, which means it does not have to pay federal income tax. Its profits and losses go straight through to the owners who pay taxes on them at the individual rate that applies to them on their personal return. Since only the members pay tax, there is a single level of taxation. However, an LLC can decide whether it wants to be a pass-through entity or to be taxed as an independent legal entity.
For many years, Borenius has helped foreign-owned companies establish and manage subsidiaries in the US by providing a range of corporate, tax, and business services. Borenius’ lawyers are available to assist in addressing any questions you may have concerning the choice of the right legal entity for your business.