It is important to note that there are two separate and distinct uses of the LP and LLC. One use is for the operation of a business and the other is for the holding of assets. In some cases the two uses are accomplished by one entity. LPs and LLCs, as well as General Partnerships, Corporations and Sole Proprietorships, have been used for either purpose. Throughout this book, by distinguishing between the two uses – business operations and asset holdings – the intent is to arrive at the best possible entity selection for your particular purpose.
Using Advisors
As we go through the chapters there will be instances where I suggest you consult with your professional advisor – be it a lawyer, accountant or other professional. In other books I have written, some readers have been upset by these references, their concern being why pay for a book that directs them to a high-priced professional.
My answer to this is three-fold. First, by reading this book you will become well educated in the field. You will either know with certainty – or have a very good idea – on how to start. By not requiring your professional to educate you on basic business concepts (i.e., types of entities, flow-through taxation issues, preliminary estate planning concepts and basic business skills), you have already saved hundreds, if not thousands, of dollars in consultation fees. By being able to walk into a professional’s office with a strategy and a set of specific questions to which you couldn’t find an answer or didn’t quite understand, you will be able to get right to the heart of the matter, saving time and money. Your professional can play devil’s advocate with your strategy or suggest certain fine-tuning elements to enhance it, meaning that the consulting fee you wind up paying has a far greater value than if you walked in off the street cold, with little or no idea on how to begin capturing your dream. In other words, use your professional to maximize your strategy.
Secondly, the laws in the areas we are covering can be broad and sometimes complex. One book cannot cover every nuance. By giving you a heads-up on the fundamentals of a certain topic, your advisor can instead concentrate their time on the technical details and most tax-beneficial strategy for you. By focusing their effort on the technicalities, they may be able to refine your strategy in a manner that will save you several thousand dollars in your business. And that’s how you should look at your accountant or lawyer – from a cost benefit analysis approach. Should you spend $750 on an accountant to save $5,000? It’s your choice. Because certain laws and tax regulations are downright and annoyingly complex, it is really not worth your time to deal with them. You likely have a business to run and a family to raise. You don’t need to be spending your weekends learning the arcania of the recapture rules for depreciable assets. Pay someone who does it for a living to do it for you. And remember, while our laws can be complex, in complexity comes advantage. Working with a professional to take advantage of complexity can be very worthwhile. The rich have done so for a very long time.
The third part of my answer is that by reading this book you will be better able to judge your advisor’s capabilities. You don’t want to retain or continue with just any professional. You have the right to deal with the professional with whom you are most comfortable and in whom you have the most confidence. If the lawyer or accountant you are interviewing tells you to put rental property into a C Corporation, you will know to get up and walk out. That knowledge alone can also save you thousands of dollars in the long run.
Types of Entities
The best way to select the entity most suited to your use is to compare it to other available entities. In addition to LPs and LLCs, the traditional means of doing business or holding assets have been Sole Proprietorships, General Partnerships, C Corporations and S Corporations. We shall compare the advantages and disadvantages of each.
As a frame of reference for making your selection, it is important to clarify your strategy during the planning process. To that end, the following checklist should be considered:
1. The nature of the business to be operated.
2. The nature of the asset to be held.
3. Protection of family assets and investments.
4. Management control.
5. The number of owners involved.
6. Estate planning and gifting of assets.
7. Succession of children and other family members to management.
8. Avoiding family disputes.
9. Who may legally obligate the business.
10. Flexibility of decisions making.
11. The need for start-up funding.
12. Taxation.
13. Effect upon an owner’s death or departure.
14. Segregation of assets and investments.
15. Privacy of ownership.
These and other issues will become apparent as we review your choices. And, if after reading this book you still aren’t sure which entity is best for your business plan, then ask your advisor to clarify what you don’t understand. An attorney, accountant or other professional advisor well versed in this area should be able to answer your remaining questions so you can arrive at the best entity selection for you. If need be, you can call our office for a consultation.
Before we begin comparing LLCs, LPs and Corporations, it is important to know the language of each. While their basic structure is similar, the terms for each structural facet are different.
The Language of Corporations, Limited Liability Companies, and Limited Partnerships
Also, because we will be primarily discussing LLCs and LPs, and there are similarities to both, we shall use the following common terms for the review of both:
We shall also use the term “better practice” to indicate a situation which may not be legally required by statute but is proper for the efficient, ethical and stress-free operation of the entity.
Before engaging in our discussion of the relevant entities it is important to see how they can relate to real-life situations; the scenarios that you and your family face right now, as you are reading this book. For that reason, we shall look at our first two case studies as a starting point for understanding.
Case Examples:
Case Number 1 – John and Liz
John and Liz have been friends since their college days together. They have both worked for large companies over the years and have grown weary of the nonsensical corporate politics and less than rapid response to marketplace changes. They want to be part of a nimble, focused and responsive organization that can take advantage of market opportunities as they present themselves. They want to maximize their prior experiences and consult with other businesses in their area of expertise.
After initially talking about starting their own business, John and Liz begin to focus on what it would really take. They consider all aspects of the issue. On the business side they read a number of business startup guides and talk to local entrepreneurs for advice. On the emotional and psychological side they consider what effect a start-up might have on their families.
Once they feel they are mentally and financially prepared, John and Liz decide to move forward with their consulting business. They know from their readings and discussions with other business people that they need a limited liability entity, be it a Corporation or an LLC. They have raised $100,000 between them for their initial round of financing, which they believe will get them through the first year of business. It is projected that they will lose at least $70,000 in the first year of business. With the help of their accountant, they decide they should utilize a flow-through entity for tax purposes.
In terms of taxation, Sole Proprietorships, General Partnerships, S Corporations, LLCs and LPs are all flow-through tax entities.