The Different Types Of Delaware Business Entities

What is a Limited Liability Company (LLC)?

An LLC is a relatively new type of entity in the U.S. It combines the limited liability of a corporation with the pass-through taxation of a partnership. Owners (or members, as they are called) of an LLC can be individuals or any type of entity, from anywhere in the world, and unlimited in number.

Using a Delaware LLC, non-resident aliens of the U.S. can legally avoid all U.S. federal taxes for their non-U.S. business activities.

American clients use LLCs for the tax benefits also, but the primary reason for using the LLC in the U.S.A. is its heightened protection against judgment creditors. In a General Corporation, formalities must be followed or creditors can destroy the protection from personal liability by "piercing the corporate veil". These formalities, such as shareholders and directors meetings, minutes, officers and director elections can be eliminated in the LLC, thus making it much more difficult to pierce.

In addition, a judgment creditor of a member of an LLC cannot seize control of the assets of the LLC or the members' voting rights, as they may be able to do with a corporation.

The LLC is a hybrid business vehicle that combines some of the best features of corporations and partnerships. Like a corporation, an LLC has a legal existence separate and distinct from its owners, and its owners and managers are not personally liable for the company's debts and obligations. Like a partnership, an LLC can be treated as a pass-through entity for tax purposes. This feature, when combined with non-U.S. source income, means non-resident aliens of the U.S.A. will avoid all U.S. taxation when using an LLC.

The operations and management of the LLC are governed by a written agreement among its owners that is not required to be publicly filed or disclosed to the Delaware Division of Corporations. As a result, an LLC allows secure anonymity and the ability to create a customized management structure, which prescribes the economic relationship among owners. The agreement can be written in any language and is not required to be translated into English.

The Delaware LLC statute allows parties to define their business relationship in a written agreement as they so desire. This is called "freedom of contract". Delaware law provides rules only for those matters on which the parties have failed to agree. The stated policy of the Delaware LLC law is to give maximum effect to the principle of "freedom of contract" and to the enforceability of LLC agreements. The contractual flexibility offered by the Delaware Act is unmatched by any other LLC statute.

Please, visit The HBS Blog, for more information on the LLC agreement

By checking the appropriate box when applying for an Employer Identification Nunber (EIN), a Delaware LLC will be treated as a partnership for Federal income tax purposes; therefore, it will not be subject to U.S. Federal income tax. For non-resident aliens of the U.S.A., this means Delaware is an attractive jurisdiction for benefits typical of many "offshore jurisdictions". Combine that with the added strength of the U.S.A.'s fiscal infrastructure, and you have an attractive comparative advantage.

While the Delaware Act permits a Delaware LLC to be managed by its members, it does not require members to be managers. More importantly, it also provides that no member or manager is obligated personally for any debt, obligation or liability of the Delaware LLC solely by reason of being a member or acting as a manager. This limitation on personal liability compares favorably with the limitation on personal liability enjoyed by shareholders of a Delaware corporation.

If properly selected on the SS-4 form, a Delaware LLC will be treated as a partnership for Federal income tax purposes; therefore, it will not be subject to U.S. Federal income tax. This means that a Delaware LLC can offer the same tax advantages as a Subhapter S corporation or a limited partnership, including the ability to provide through a written agreement for allocations of income and/or distributions to members in amounts which differ from the members' economic interest in the LLC, as well as the ability to provide a basis to members for non-recourse debt. A Delaware LLC will also provide greater tax flexibility in areas of distributions and can be used as a valuable tool for estate planning and wealth transfers.

What is a General Corporation?

In many situations, a general corporation, often referred to as the "stock corporation," "open corporation," or "C Corporation," is recommended, especially when there will be more than 30 shareholders in a company, such as a company planning to "go public" or planning a private offering of stock.

A general corporation is allowed a broad spectrum of flexibility. This is thanks to the general corporation laws of Delaware and the legal cases that have set a 200-year consistent pattern of respecting good-faith management decisions.

A general corporation typically has three tiers of power: the Shareholders, the Directors, and the Officers. Each of these groups has different rights and responsibilities within the corporation.

* The Shareholders are the owners of the company, but they do not manage the company. Typically, holders of common stock have the right to one vote for each share they own to elect the members of the Board of Directors and to vote on certain other matters of major significance to the company.

Any stockholder who holds a majority of the shares of issued stock can control the company. This is sometimes referred to as a "majority shareholder". Majority shareholders take on a heightened responsibility to minority shareholders.

Minority shareholders (any stockholder without a controlling role in the company) generally have no responsibility to the company. They can usually sell their stock whenever they want and they can assign or give their votes to anyone else they choose.

Shareholders are rewarded in two ways: (1) the dividends paid on their stock when and if the Board of Directors declares a dividend; and (2) the increase in the value of their stock when the company grows.

* The Directors run the company and are responsible for the overall management of the company. They take responsibility for all major business actions such as the issuance of stock, the election of officers, hiring of key management, the establishment of corporate policies, and the setting of their own and key officers' salaries and compensation packages.

Directors decide IF a dividend will be given to the shareholders, and if so, how much. Directors issue stock in the company, and they may own stock in the company themselves.

Directors have certain fiduciary responsibilities to their company. They must be loyal to the company; they must make informed, independent decisions as board members; they must not act in bad faith, such as self-dealing or fraudulent dealings; and they must act in the best interests of the company and its shareholders.

Directors may make decisions and take action in either of two ways: in pre-announced meetings with a quorum present, or without a meeting by unanimous written consent of all directors. Directors cannot give or sell their votes to another Director or vote by proxy.