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After discussing the tax implications and registration and maintenance costs that one needs to consider when choosing an ownership structure, we now explore the efforts needed to stay in compliance with regulations for an S Corp and an LLC.

Limited Liability Company (LLC)

Articles of Organization

Because an LLC is treated as a separate entity, forming an LLC also requires the filing of an Articles of Organization (or Certificates of Organization in some states). This is the equivalent of a corporation’s Articles of Incorporation. As mentioned in my previous post, preparing the Articles of Organization is a breeze compared to preparing the Articles of Incorporation because you simply need to fill out a one-page form. You will need to have answers for the following to fill out the form:

1. Name of LLC
2. Registered agent
3. Address of individual registered agent
4. How many members will be managing the LLC
5. Your name as organizer

Operating Agreement

Although an Operating Agreement is not required to form an LLC, it is highly recommended to protect your partners’ and your interests. Some of the basic information included in an Operating Ageement records members’ percentage of interests in the business, voting power and rights and responsibilities in day-to-day operations. This is also a good place to document who will be managing the LLC. Depending on your agreement with your partners, you may decide to divvy up profits in a manner disproportionate to ownership interests. Note such important decisions here as well to avoid future disputes. There are some very difficult questions that you need to address because these questions are typically not things you would consider especially when everything seems to be perfect when you are just forming an LLC. Examples of these questions are “What happens when a member decides to leave the LLC?”, “Will the member be compensated for giving up his ownership interest?” and “What happens when a member dies?” You will need to talk this through with your partners now before these scenarios happen because when they do they have a tendency to end up in court and destroy decades worth of friendship.

S Corporation

Because an S Corporation is simply a corporation with a different tax structure, an S Corp must satisfy all compliance requirements as demanded of its brethren.

Annual Shareholders Meetings

Before you can start running your business, the first step after you have filed your Articles of Incorporation is to hold your first annual shareholders meeting to elect the directors of your corporation. The meeting minutes and the voting decisions made in the meeting must be recorded. Templates for meeting minutes are freely and readily available on the Internet.

Initial Board Meeting

Immediately following the initial shareholders’ meeting, the directors will hold the initial board meeting. In this meeting, the board of directors will nominate the officers of the company. Again, the decisions must be recorded in detail.

Corporate Bylaws

Next you will need to prepare the Corporate Bylaws, much like the Operating Agreement of an LLC, detailing the rules governing the operation of the business. You do not need to file this document with the state, but you will need to keep it in your records for whenever a shareholder demands to review the bylaws.

Stock Issuance

To prove your ownership interest in the corporation, you will need to issue stock certificates to each shareholder. You don’t need a fancy, forgery-proof certificate. Just make sure it is signed by the officers and well documented (i.e. record the amount of capital contributed in exchange for the shares).

Resolutions

Any major decisions in a corporation such as opening a bank account, entering into a revolving credit agreement, and purchase and sale or major assets, mergers and acquisitions and dissolution must be recorded in detail.

Comparing an LLC to an S Corp

Compared to an LLC, the formality requirements for an S Corporation can be overwhelming. However, these paperwork requirements also force you to treat your business like one. When creditors, lawyers and IRS scrutinize your records, you will be grateful that you have everything in written order. It’s no longer just your words against theirs. I don’t enjoy doing all the paperwork, but since I lack discipline, I need rules to help keep me organized. After considering the pros and cons based on the articles in this series, I convinced myself to go with an S corporation. To paraphrase Warren Buffett, “I’m very good at convincing myself.”