Business Entities

May 1, 2001

9 Min Read
Business Entities

Choosing the Form of Your Business Entity

By Jeffrey Greenberger

Thiscolumn provides general insight into the legal aspects of self-storage andshould not be substituted for the advice of your own attorney.

"To LLC or not to LLC--that is the question." If the great bardShakespeare were alive today, the form of the business entity that owned theGlobe Theater would be of far more importance to him than the metaphysicalquestions posed in Hamlet.

All analogies aside, in this day and age, it is extremely importantself-storage owners don't overlook anything they can do to insulate themselvesfrom liability in the event of an unexpected disaster or business failure. Thisis a difficult topic to cover since the laws of each state vary regarding theforms of business permitted, and the specific rules and regulations that applyto them. This article is intended to give you a general overview of the issue ofselecting a business entity. Please discuss any plans to form a specific entitywith your attorney.

Business Entities

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 smallself-storage operator. It provides the same type of protection from certainindividual liability as non-electing corporations and provides the benefits ofavoiding double taxation on earnings. But S-Corps have other limitations; forexample, the number of shareholders is limited to approximately 35 and regularminute 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 liabilitycompanies (LLCs) in various states, and most now permit an LLC in some form. AnLLC allows the same type of insulation from certain types of personal liabilityfor actions of the business, allows for single taxation of earnings, and alsohas less rigid requirements for the type of record keeping typically associatedwith corporation law. But before you drop this issue of ISS to call yourattorney, LLCs and S-Corps are not the solution to every problem in yourbusiness.

Here are some things to consider: First, several of the things you can dowith an LLC or an S-Corp can also be accomplished by purchasing good businessinsurance with a large business-liability umbrella policy and a large personalumbrella policy. Second, the assets of the business in the LLC or S-Corp arealways at risk. Finally, there are certain types of actions that give rise toliability that cannot be insured against and from which you cannot form anentity to avoid personal liability.

Examples of these types of conduct are: failure to pay certain payroll trusttaxes; certain wrongful-discharge and sexual-harassment charges; violation ofcertain consumer-protection laws; willful or malicious and criminal types ofacts; and contract obligations, such as trade debt. Most--if not all--insurancepolicies exclude payment for these types of damages. No matter what businessentity you have set up, your personal and other business assets cannot beprotected.

Here's an example: If you are accused of improperly discharging an employeeof your facility with the allegation of some type of sexual harassment, yourinsurance 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 personalresponsibility to the person who actually conducted or permitted the allegedact. To the extent a judgment is rendered, it would be against the business andyourself. The fact that your business is in the form of an S-Corp or an LLCwould grant you no additional protection.

On the other hand, let's say an employee, in the course of his work, isdriving the company vehicle and crosses the center line, hitting a bus andkilling 25 people. Your insurance in not adequate to cover the amount of damagesawarded. Having your business in the form of an LLC or an S-Corp will allow youto limit that which is subject to attachment to the assets of the business. Youwill be able to insulate from judgment your personal assets and other businessventures. You may lose the facility, but will be able to protect your home, bankaccounts, automobiles, etc.

The best reason to consider setting up an LLC or an S-Corp is the unfortunateevent the business fails. Obviously, there is no insurance against a businessfailing and, if it does, there will most likely be many unpaid creditors fromthe business. If you have not personally signed or guaranteed debts, and youwere properly set up and operated as an S-Corp or LLC, creditors can onlycollect the debts from the business assets. Conversely, if you were doingbusiness as a sole proprietorship or a partnership, your creditors would be ableto look beyond the assets of the business to your own personal assets and assetsof 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: Ifyou are an owner or part owner, or have interest in multiple facilities or otherbusinesses, setting up an LLC or an S-Corp can help insulate the liabilitiesbetween each business. For example, let's say you own a successful manufacturingbusiness and two self-storage facilities. All three are separate entities suchas C-Corps, S-Corps or LLCs, and they are not cross collateralized. If one ofthe facilities fails, you would be able to insulate the other facility and yourmanufacturing 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 yourpersonal assets. In addition, the setting up of an LLC or S-Corp will notinsulate your interest in the LLC or S-Corp from personal judgments. Forexample, if while driving home one night you cross the double yellow line andhit the same bus as the employee we mentioned earlier, you would have personalliability to pay for the injuries or deaths that occurred. This is why you carrypersonal-liability insurance through your automobile policy.

However, in the event your policy does not have enough dollar coverage toaddress all the potential claims of the victims, a judgment could be renderedagainst you personally. Your insurance company would only have to pay the limitsof its policy, and the balance would be collected from your personal assets suchas your home, cars, bank accounts, etc. If these personal assets proveinsufficient, one of the other assets creditors can attach is your interest inany 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 andtry to force the business to be liquidated.

So we have come full circle. An LLC or S-Corp is not a substitute for properinsurance, but a soundly formed business entity complements a good business planand personal insurance. It can insulate your other assets and businesses fromliability in the event something goes awry within your self-storage operation.It also insulates the facility in the event something happens in another one ofyour businesses.

There are multiple other requirements to properly operate your business inthe form of an S-Corp or LLC, and your attorney can help you with these. Forexample, it is important for the public to know you are operating in a specificbusiness form. This is why businesses include the notations "Inc.,""Co." or "LLC" after their names. If you are operating inthe form of an LLC or S-Corp and are not identifying yourself to the world viayour signage, invoices, checks and document signatures that you are operating inthis form, you may be waiving the protections granted under the LLC or S-Corplaws in your state. If you are an S-Corp, you should be signing all documents onbehalf 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, youcould 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 operatingas an LLC. The letters "LLC" or the words " limited liabilitycompany" must appear in the title of your business, on your letterhead andon 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 yourcapacity as a "member" of the LLC. There are many ways to ensure theworld knows you are operating as an LLC or corporation. The above examples areones I often see businesses not using. They are running the risk of losing theirprotection after going to all the trouble of forming a business entity!

My firm generally recommends the LLC form for self-storage owners. The truebeauty of an LLC--if it is available in your state--is it is not particularlyexpensive to form, and not particularly intensive in terms of maintenance, laboror attorneys' fees once properly formed. However, there is a learning curveinvolved in getting up to speed as an LLC. There are printing and signage coststhat are unattractive to small-business owners, but they are minute compared tothe 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 yourattorney to ensure you are up-to-date with your documents and filings to theappropriate authorities in your state. If you are operating as a soleproprietorship, partnership or limited partnership, give serious thought towhether 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 ofcommercial real estate, including self-storage. Mr. Greenberger, licensed topractice law in Ohio and Kentucky, is the legal counsel for the Ohio SelfStorage Owners Society and the Kentucky Self Storage Association, as well as aregular presenter at Inside Self-Storage Expos. Questions, comments orsuggestions for future topics can be sent to Jeffrey Greenberger c/o Katz,Greenberger & Norton LLP, 105 E. Fourth St., Suite 400, Cincinnati, OH45202; call 513.721.5151; e-mail [email protected].

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