Choosing the Form of Your Business Entity
By Jeffrey Greenberger
This column provides general insight into the legal aspects of self-storage and should not be substituted for the advice of your own attorney.
"To LLC or not to LLC--that is the question." If the great bard Shakespeare were alive today, the form of the business entity that owned the Globe Theater would be of far more importance to him than the metaphysical questions posed in Hamlet.
All analogies aside, in this day and age, it is extremely important self-storage owners don't overlook anything they can do to insulate themselves from liability in the event of an unexpected disaster or business failure. This is a difficult topic to cover since the laws of each state vary regarding the forms of business permitted, and the specific rules and regulations that apply to them. This article is intended to give you a general overview of the issue of selecting a business entity. Please discuss any plans to form a specific entity with your attorney.
There are several forms of business entities that exist somewhat universally:
- A Proprietorship--A proprietorship is any business, owned by one or more people, that has not formally filed for recognition with the appropriate authority of the state in which it is located.
- General Partnership--A formal ownership arrangement between two or more individuals or entities that provides no additional protection or insulation from liability to the individual owners.
- Limited Partnership--Limited partnerships allow certain owners/investors to limit their exposure or risk for liability to the sum total of their investment. However, every limited partnership must have a general partner. The general partner--including all his individual assets--is exposed to all liability from the investment. The general partner can be an individual or another form of a business entity.
- The Corporate Form--We are all familiar with a basic corporation format, such as large Fortune 500 companies. The corporate form (the "C-Corp") provides the benefit of insulating, to a certain extent, the personal assets of the shareholders from liability in the event the business fails. The IRS permits certain corporations to make what is called an "S" election, which allows qualified corporations to be taxed like a partnership and avoid the potential double tax on corporate earnings that apply to businesses without it.
Until about 10 years ago, the S-Corp was the best corporate form for a small self-storage operator. It provides the same type of protection from certain individual liability as non-electing corporations and provides the benefits of avoiding double taxation on earnings. But S-Corps have other limitations; for example, the number of shareholders is limited to approximately 35 and regular minute books and resolutions have to be kept, just like in a C-Corp.
Limited Liability Company
About 10 years ago, we also began to see the emergence of limited liability companies (LLCs) in various states, and most now permit an LLC in some form. An LLC allows the same type of insulation from certain types of personal liability for actions of the business, allows for single taxation of earnings, and also has less rigid requirements for the type of record keeping typically associated with corporation law. But before you drop this issue of ISS to call your attorney, LLCs and S-Corps are not the solution to every problem in your business.
Here are some things to consider: First, several of the things you can do with an LLC or an S-Corp can also be accomplished by purchasing good business insurance with a large business-liability umbrella policy and a large personal umbrella policy. Second, the assets of the business in the LLC or S-Corp are always at risk. Finally, there are certain types of actions that give rise to liability that cannot be insured against and from which you cannot form an entity to avoid personal liability.
Examples of these types of conduct are: failure to pay certain payroll trust taxes; certain wrongful-discharge and sexual-harassment charges; violation of certain consumer-protection laws; willful or malicious and criminal types of acts; and contract obligations, such as trade debt. Most--if not all--insurance policies exclude payment for these types of damages. No matter what business entity you have set up, your personal and other business assets cannot be protected.
Here's an example: If you are accused of improperly discharging an employee of your facility with the allegation of some type of sexual harassment, your insurance may not cover this type of action. The assets of your business would, as always, be at risk. But in many states, the law imputes personal responsibility to the person who actually conducted or permitted the alleged act. To the extent a judgment is rendered, it would be against the business and yourself. The fact that your business is in the form of an S-Corp or an LLC would grant you no additional protection.
On the other hand, let's say an employee, in the course of his work, is driving the company vehicle and crosses the center line, hitting a bus and killing 25 people. Your insurance in not adequate to cover the amount of damages awarded. Having your business in the form of an LLC or an S-Corp will allow you to limit that which is subject to attachment to the assets of the business. You will be able to insulate from judgment your personal assets and other business ventures. You may lose the facility, but will be able to protect your home, bank accounts, automobiles, etc.
The best reason to consider setting up an LLC or an S-Corp is the unfortunate event the business fails. Obviously, there is no insurance against a business failing and, if it does, there will most likely be many unpaid creditors from the business. If you have not personally signed or guaranteed debts, and you were properly set up and operated as an S-Corp or LLC, creditors can only collect the debts from the business assets. Conversely, if you were doing business as a sole proprietorship or a partnership, your creditors would be able to look beyond the assets of the business to your own personal assets and assets of other businesses you own (even LLCs), for collection of the amounts due.
This leads us to the second best reason to form an LLC and/or an S-Corp: If you are an owner or part owner, or have interest in multiple facilities or other businesses, setting up an LLC or an S-Corp can help insulate the liabilities between each business. For example, let's say you own a successful manufacturing business and two self-storage facilities. All three are separate entities such as C-Corps, S-Corps or LLCs, and they are not cross collateralized. If one of the facilities fails, you would be able to insulate the other facility and your manufacturing business from the creditors of the failed facility.
Other Things to Think About
The formation of a business entity like an LLC or an S-Corp is not a panacea. There are certain actions and liabilities from which you cannot insulate your personal assets. In addition, the setting up of an LLC or S-Corp will not insulate your interest in the LLC or S-Corp from personal judgments. For example, if while driving home one night you cross the double yellow line and hit the same bus as the employee we mentioned earlier, you would have personal liability to pay for the injuries or deaths that occurred. This is why you carry personal-liability insurance through your automobile policy.
However, in the event your policy does not have enough dollar coverage to address all the potential claims of the victims, a judgment could be rendered against you personally. Your insurance company would only have to pay the limits of its policy, and the balance would be collected from your personal assets such as your home, cars, bank accounts, etc. If these personal assets prove insufficient, one of the other assets creditors can attach is your interest in any business. In this example, it does not matter if you are a partnership, S-Corp or LLC--creditors would simply attach your share of the partnership and try to force the business to be liquidated.
So we have come full circle. An LLC or S-Corp is not a substitute for proper insurance, but a soundly formed business entity complements a good business plan and personal insurance. It can insulate your other assets and businesses from liability in the event something goes awry within your self-storage operation. It also insulates the facility in the event something happens in another one of your businesses.
There are multiple other requirements to properly operate your business in the form of an S-Corp or LLC, and your attorney can help you with these. For example, it is important for the public to know you are operating in a specific business form. This is why businesses include the notations "Inc.," "Co." or "LLC" after their names. If you are operating in the form of an LLC or S-Corp and are not identifying yourself to the world via your signage, invoices, checks and document signatures that you are operating in this form, you may be waiving the protections granted under the LLC or S-Corp laws in your state. If you are an S-Corp, you should be signing all documents on behalf of the corporation, in your official capacity in the corporation. Further, if you are a corporation and have not kept your minutes up to date, you could be running a risk of someone claiming your corporation is no longer valid.
The same requirements exist for an LLC. The world must know you are operating as an LLC. The letters "LLC" or the words " limited liability company" must appear in the title of your business, on your letterhead and on your checks. Checks received should be made payable to the business as an LLC, not to you personally. Correspondence and checks should be signed by you in your capacity as a "member" of the LLC. There are many ways to ensure the world knows you are operating as an LLC or corporation. The above examples are ones I often see businesses not using. They are running the risk of losing their protection after going to all the trouble of forming a business entity!
My firm generally recommends the LLC form for self-storage owners. The true beauty of an LLC--if it is available in your state--is it is not particularly expensive to form, and not particularly intensive in terms of maintenance, labor or attorneys' fees once properly formed. However, there is a learning curve involved in getting up to speed as an LLC. There are printing and signage costs that are unattractive to small-business owners, but they are minute compared to the costs of losing your home, or other business interests or assets.
If you are already in a corporate form, it is worth a phone call to your attorney to ensure you are up-to-date with your documents and filings to the appropriate authorities in your state. If you are operating as a sole proprietorship, partnership or limited partnership, give serious thought to whether an LLC or S-Corp might be a better business form for you.
Jeffrey Greenberger practices with the law firm of Katz, Greenberger & Norton LLP in Cincinnati, which represents owners and operators of commercial real estate, including self-storage. Mr. Greenberger, licensed to practice law in Ohio and Kentucky, is the legal counsel for the Ohio Self Storage Owners Society and the Kentucky Self Storage Association, as well as a regular presenter at Inside Self-Storage Expos. Questions, comments or suggestions for future topics can be sent to Jeffrey Greenberger c/o Katz, Greenberger & Norton LLP, 105 E. Fourth St., Suite 400, Cincinnati, OH 45202; call 513.721.5151; e-mail JJG@kgnlaw.com.