Many entrepreneurs are familiar with the basic concept of incorporating or organizing a business entity; however, there are so many different types of entities that an entrepreneur can become understandably confused. We recognize those letters at the end of the company name: Inc., Ltd., P.C., LLP, or LLC. What do these mysterious letters mean and what are the basic distinctions between these entities?
General Business Corporations (Corp., Co., Inc., Ltd.)
The most common and well-known business entity is the general business corporation. These are for-profit entities created in Missouri by “The General and Business Corporation Law of Missouri” and in Illinois by the “Business Corporation Act of 1983.” The true names of corporations must include the word “corporation”, “company”, “incorporated”, “limited”, or an abbreviation thereof.
Since the general business corporation is the most well-known entity, you are undoubtedly familiar with the major parties involved in the corporation: the shareholders own the corporation through stock and elect the Board of Directors. The Board of Directors oversees the corporation and elects its officers. The officers are responsible for the day-to-day management of the corporation. Missouri corporations are required by law to have a president and a secretary. Illinois and Missouri corporations may also create such other officers as they deem appropriate. Corporations come in a vast variety of sizes, from a giant, multinational corporation to a single business owner.
Notwithstanding the different positions that a corporation may have, it is fairly common for a single person to hold all of these roles in a small corporation: sole shareholder, sole director, president and secretary.
Statutory Close Corporations
A statutory close corporation is a general business corporation under Missouri or Illinois law that elects to be treated as a “close corporation.” Close corporations generally are structured similarly to general business corporations, but there are a few notable benefits and restrictions:
Close corporations may elect to eliminate the Board of Directors, in which case the shareholders oversee the corporation directly.
In Missouri, close corporations have default provisions restricting transfers of the stock to a third party and providing for the corporation to have a first option on the purchase of any shares. Illinois likewise imposes an automatic first option in favor of the corporation on any shares transferred in violation of restrictions agreed to by the shareholders.
In Missouri, close corporations may also opt to eliminate bylaws and shareholder meetings, which simplifies the organization and governance process. (However, such simplification may be ill-advised: See our article “Meeting Minutes and Written Consents: Sound Reasons for Complying With a Simple, Yet Necessary, Task.”)
Many of the restrictions and operating processes special to statutory close corporations (such as the restrictions on sale and the first purchase option) may be created for other business entities, but since they are not specifically provided for by statute, creating these arrangements require independent documents and agreements.
Professional Corporations (P.C.)
Professional Corporations are corporations created in Missouri under the “The Professional Corporation Law of Missouri” and in Illinois by the “Professional Service Corporation Act.” You can identify professional corporations since their name must contain the words “Professional Corporation” or the initials, “P.C.” (or, in Illinois, “Chartered,” “Limited” or “Ltd.”) Professional corporations typically operate in the same manner as general and business corporations; however, they are limited to specific, licensed professionals, including (in Missouri), the following: accountants; architects or engineers; attorneys; chiropodist-podiatrists; chiropractors; dentists; optometrists; physicians or surgeons; psychologists; veterinarians; registered nurses; licensed real estate salespersons; and physical therapists.
Illinois law does not enumerate the professions, but simply limits the availability of a professional corporation to those professions which obtain state licensure. A professional corporation may only be owned (directly or, in some circumstances, indirectly) by the licensed professional individuals, their trusts, or certain authorized entities, and the professional corporation is limited to performing that professional work and certain related work.
Each licensing body has its own separate requirements; however, many of the licensing bodies require licensed professionals to operate as corporations only through professional corporations and prohibit the use of general business corporations. Aside from these requirements of the licensing body, some individuals may choose to operate as a professional corporation due to certain tax benefits (including certain fringe benefits), available to professional corporations.
Non-profit corporations are authorized in Missouri by the “Missouri Nonprofit Corporation Act” and in Illinois by the “General Not For Profit Corporation Act of 1986.”
In Missouri and Illinois, non-profit corporations may only be organized for certain enumerated purposes, including such purposes as: charity; benevolence; education; civic purposes; patriotic purposes; political purposes; religion; culture; social welfare; health; social purposes; literary purposes; athletic purposes; scientific purposes; research; or commercial, industrial, or trade association purposes.
In many respects, non-profit corporations operate similarly to general business corporations with officers and directors, with a couple of important differences. Missouri and Illinois non-profit corporations must have at least three directors. In Missouri, the Board of Directors may also be referred to as the Board of Trustees, a Board of Regents, or a Board of Overseers. Missouri and Illinois non-profit corporations also do not have shareholders, but they may have “Members,” who are individuals with a right to elect Board members.
Although the terminology can be understandably confusing, incorporation as a non-profit corporation does not automatically grant tax-exempt status (commonly known as 501(c) status) to the non-profit corporation. Separate applications must be made to the Internal Revenue Service in order for a non-profit corporation to be exempt from federal, and by extension state, taxes.
A word about “S” and “C” corporations
Sometimes people hear about “S” and “C” corporations and assume they are a different type of corporation. Not so! Corporation formation is governed by state law—the “S” and “C” refer to how the corporation is treated by the federal tax code. General business corporations, close corporations, professional corporations and non-profit corporations can all be either “C” or “S” corporations, if they qualify. All corporations will be “C” corporations unless they qualify and elect to be treated as subchapter “S” corporations. There are many differences between “C” and “S” corporations, but the biggest distinction is that income to a “C” corporation is taxed at the corporate level, and taxed again when distributions are made to the shareholders. By contrast, an “S” corporation does not pay taxes at the corporate level, and all tax treatment passes through to the shareholders at the individual level.
Limited Liability Companies (LLC)
A limited liability company is formed by organizing in Missouri pursuant to the Missouri Limited Liability Company Act and in Illinois pursuant to the Limited Liability Company Act. A limited liability company is neither a corporation nor a partnership (see below), but a flexible hybrid of the two. You can identify limited liability companies by their name, which must contain the words or initials “limited liability company”, “LLC”, “L.L.C.”, or (in Missouri) “limited company” or “L.C.”
An LLC can be formed (this formation is referred to as organization, rather than incorporation) either as Member-Managed or Manager-Managed. The Members, like shareholders, own the limited liability company, and the structure and powers of the LLC are set forth in the Articles of Organization and in an Operating Agreement. A Member-Managed company is operated by its Members, similar to a partnership. In a Manager-Managed company, the Members elect the Managers, and the Managers operate the company, similar to a Board of Directors. The LLC act does not provide for nor require officers, but the LLC can also informally create “officers” like a president and a vice-president, and delegate such authority to those offices as the Members and/or Managers see fit. In fact, one of the benefits (and potential drawbacks) of an LLC is that it is incredibly flexible, and the management structure can be arranged in nearly any way the Members desire. A downside to the LLC is that because they are so flexible, the law carries fewer default arrangements, and the Members must anticipate and prepare for more contingencies than they would in a corporation.
Illinois also permits the creation of a “Series Limited Liability Company.” This entity exists in only a handful of states, and Illinois’s version is somewhat unique. Essentially, the statute permits a single LLC to create separate “cells,” which may operate independently from the other cells and from the “parent” LLC. Each cell has limited liability with respect to the other cells, the parent, and the Members. Since this entity is relatively new, little case law exists to provide guidance on Series LLC’s; however, it appears particularly well designed for real estate practice, where each “cell” can hold a separate parcel of property under the larger umbrella of the “parent” LLC.
Partnerships: Partnerships come in a variety of forms. With the growth of LLC’s, partnerships have become less common as vehicles for ordinary business operations. Nonetheless, they continue to find niches for particular business practices and for estate planning purposes. They also arise by operation of law when two or more individuals or businesses enter into a business arrangement, generally referred to as a “joint venture,” without the benefit of forming either a corporation or LLC.
General Partnerships: Under the codification of the common law, a general partnership is deemed formed when an association of two or more persons carry on as co-owners of a business for profit. General partnerships are not registered with the state. Since there is no limited liability for general partnerships, few people knowingly choose to form a general partnership unless they also elect limited liability status, discussed below.
Limited Partnerships (LP’s): The Limited Partnership is an entity formed under Missouri and Illinois law and which requires filing a certificate of Limited Partnership with the Secretary of State. A Limited Partnership must have one or more general partners with unlimited liability, but can also have as many limited partners as it chooses. Limited partners have limited liability (to the extent of their contribution). LP’s are available in both Missouri and Illinois.
Limited Liability Partnerships (LLP’s): Limited Liability Partnerships are general partnerships that have elected, by registration with the state, to have limited liability for all partners. In LLP’s, all partners are shielded from the partnership’s liability. LLP’s are available in both Missouri and Illinois.
Joint Venture: A joint venture is a partnership formed for a specific project. These are typically the product of an arrangement between two independent companies that wish to join forces solely for a single defined project.
Special Purpose Entities: Missouri recognizes a variety of specialized entities, including domestic health services corporations, urban redevelopment corporations, farming corporations and industrial development corporations. Illinois recognizes such entities as development credit corporations, service corporations, agricultural cooperatives, and cemetery associations. These specialized entities are created under state law to address and encourage particular societal goals. An explanation of each is outside the scope of this article; however, be aware that the standard corporation, LLC and partnership choices discussed above do not capture the whole range of entities available under either Missouri or Illinois law.
Choice of Entity
The descriptions above provide only the briefest summary of the distinctions between the various organizational entities. Your actual choice of entity selection will depend on your type of business and business plan, your (and your partners’) goals, your ownership structure, and the tax implications of your business.