Understanding
Corporations, Limited Liability Companies (LLC’s) and Limited
Partnerships
By: Darius M.
Barazandeh, Attorney at Law / M.B.A.
The
best way to understand a corporation, limited liability company (or even
a limited partnership) is to realize that each creates a special legal
relationship or privilege between the business owner(s) and the
government. These areas of government include:
- State Government (including
state taxing authorities and the state court system)
- The Federal Government
(specifically the IRS and the Bankruptcy court system)
You may be saying, alright Darius, I
still don’t understand what you mean by a relationship or privilege. The
best way that I can put it is this:
A business entity is a legal relationship
which allows for certain privileges. When teaching people about
entities, I like refer to an often forgotten fact: In England during the
colonial period the ability to create a corporation required an
exclusive grant (i.e., permission) from the Crown (that’s right the
King or the Queen!). Remember a business entity is a privilege!
HERE
IS ANOTHER TIDBIT: Did you know that when the original
13 colonies were established, many were actually corporations or similar
form. For example, the Maryland Company was used to settle and
develop…you guessed it, the State of Maryland. Other examples
include, the Virginia company, the Massachusetts company and others. Why
would someone use an entity to explore and colonize the New World? The
reason is that colonization and exploration were risky investments. Ships
were lost at sea, diseases ended the lives of thousands, and a host of
other risks were present with each expedition.
By setting up these expeditions as
corporations investors could contribute money but were only be liable
for the amount invested. In other words, these early arrangements
promoted exploration, development, and commerce by limiting liability
for investors. The same reasoning is true today. When liability is
limited to what you contribute to a business, people are more likely to
start businesses. THE REASON: Less risk if everything goes wrong
BUT more to GAIN when things go RIGHT!
The point of these historical facts is to
make it clear that the purpose of a business entity is to limit the
liability of owners/investors to the amount contributed to the business. These
facts should also make you realize that liability protection is a
privilege.
Why
Should you be concerned
about liability protection?
I am not here to scare you…but use
common sense. Real estate businesses require you to deal with numerous
parties, including: tenants, sellers, partners, investors, lenders,
management companies, independent contracts, employees, and others. The
more parties you deal with the more likely it is that something may not
go as planned.
The first step is to learn how to run
your business in fair and careful manner…so that you reduce the
chances of getting sued. Always remember this: A business entity (LLC,
corporation or limited partnership) is not an excuse to act in a
careless or negligent manner. You need to be fair when dealing with all
parties and you need to outline agreements with partners, vendors,
contractors, etc. You need to respond to tenant’s complaints regarding
rental property. In short you need to become a MASTER good business
practices. I spend a considerable about of time in my courses
covering a topic I call ‘Lawsuit Avoidance 101’. This means
that we teach you good business practices to help you reduce the risk of
getting sued. It’s simply so important!
Another issue to keep in mind is that
since you will be dealing with tenants, sellers, partners, investors,
lenders, management companies, independent contracts, employees, county
agents, you may get into the position where you will need to assert your
rights. In other words, you may need to take another person to
court, because your rights have been violated, a contract has been
broken, or money has not been paid to you. Many times when you
assert your rights, you may then be sued by the party you are taking to
court. I know this sounds harsh…but it happens! This is
called a ‘cross claim’ and it means that the party who is being sued
is now also suing. Usually this happens because the other party’s
attorney believes that they have a claim and/or they will be in a better
position using a cross claim. Basically this means that for you to
assert your own rights, you may risk getting sued.
ALWAYS REMEMBER THIS:
There are
also steps you can take to allow more chances for a pre-lawsuit
settlement. This makes the lawsuit truly a last resort. Ask
this question: Do you have alternative dispute resolution clauses
in your agreements? Obviously, if you can settle matters outside of
court via an alternative dispute resolution method, then may be a big
advantage and a savings of time and money. An alternative dispute
resolution clause will require parties to work at settling a claim
through mediation or another non-litigious (and less expensive) manner. Again,
a lawsuit should be the absolute last resort. We cover all of these
areas in more detail for investors because it something that most people
and even some attorneys leave out!
There are also tax advantages and
disadvantages to recognize when selecting an entity for your business. We
will discuss these in later articles.
To learn more about which entity may be
best for you and how to create, run, and maintain an ‘iron clad’ LLC
or corporation, you don’t need a grant from the King or Queen…but
you should see Mr. Barazandeh’s, Wealth
Building LLC ™
and Incorporate for Wealth™
courses.
