“LLC”, “Sub S”, “C” Corporation…
This alphabet soup of legal formations is highly confusing to many start-up franchisees.
However, just as every successful entrepreneur must understand basic accounting and insurance concepts to manage his (or her) business, it is equally important to make an informed judgment about the best legal structure for your particular franchise operation.
For every franchisee, Legal Liability and Tax Reduction should be the two most critical factors in the decision to form a legal corporate entity
Legal Liability
Legal liability is the ongoing nightmare of the American “free market system” in the 21st century. Like the rest of society, franchise business owners are strongly affected by the threat of lawsuits.
Companies that deal directly with consumers are particularly vulnerable. These would include Restaurants, Transportation Companies, Retail Stores, Health Practitioners, Training Schools and many other businesses that are frequently victimized by our legal system
Contractors, Truckers and companies that operate heavy equipment are frequently targeted by the legal system over accidents and related problems.
Remember! It only takes a word processor and a greedy plaintiff to file a lawsuit that can create years of misery for any innocent franchise operator who is perceived to to be a ripe “target of opportunity”.
The business owner who is sued invariably loses money in a court battle even if he ultimately “wins” his case … Our legal system does not typically provide defendants with financial compensation to cover the financial ( and emotional ) losses that result from defending frivolous lawsuits.
Make yourself Judgment Proof!
Relief is on the way…
Establishing a corporate entity for your franchise eliminates a significant portion of the litigation risk related to your business.
The primary role of the corporation is to protect and separate your personal assets from those of your company. Your home, cars, retirement savings and other assets are clearly insulated from your incorporated franchise(s). An adverse judgement against your business will generally be limited to the assets of your company.
In a recessionary economy, we witness increasing abuses of the legal system by “quick buck artists” who attack innocent business owners through civil litigation. With proper corporate protection, you need not expose yourself (and your family) to the frightening spectre of the grinding judicial court system.
Tax Reduction
Taxes play an important part in determining the true “after-tax profit” that the Franchisee earns from his (or her) activities. As we all know, what matters most in business is not how much money you earn, but how much money you keep at the end of each year!
It is not a coincidence that the vast majority of successful private (and publicly) held businessses throughout the world are incorporated entities. The IRS is well geared towards processing corporate returns for various forms of incorporated entities.
The tax implications of establishing a corporation can vary greatly on the basis of the franchisee’s specific tax situation. It is prudent to consult with your accountant (or tax preparer) to review the best options for your particular franchise operation.
The Best Path for Your Franchise
As an incorporating service firm, Inc. Plan (USA) has observed the following patterns of behavior by different types of business owners:
Most franchisees establish “S” corporations
Most franchisees establish “S” corporations because they they are simple (and efficient) to file as part of the owner’s personal IRS return. Gains and losses from the “S” corporation are netted against the owner’s personal income from all other sources.This is particlarly helpful during the start-up phase of the franchise because some of the early franchise expenses can help reduce your overall tax bill almost immediately.
The Limited Liability Company (LLC)
The Limited Liability Company (LLC) is an incorporated entity that does not offer share certificates to its owners. Instead, it provides a “Certificate of Formation”which is used as a blank template for the owners to formally outline how the LLC is to be divided and managed by its owners and directors. The LLC is increasingly popular vehicle with franchisees who own the real estate that is being leased by their own franchise.
The LLC is also quite popular with offshore investors who purchase franchises in the United States because LLC owners are not required to own a Social Security Card in this country.
The Passive Investment Company (PIC)
The Passive Investment Company is a holding company strategy that can be deployed by larger franchise operators for the management and maintenance of their passive assets. The PIC can, for example, be used to hold franchise licenses and intercompany debt. Larger franchisees are encouraged to contact A. David Vande Poele or Anthony Shippam at Stewart Management Company in Wilmington Delaware to learn more about how to establish a legal, tax friendly PIC in Delaware, Nevada or the Cayman Islands.
Last Thoughts about forming a Corporation
Forming a corporate entity is a simple, inexpensive and “painless” process if you work with a professional service company like Inc. Plan (USA).
Once your business entity is formed, you should organize the company’s records in a corporate kit that is customized to your company’s specific needs. The kit includes important features like minutes, bylaws and share certificates . These shares are distributed to the owners of the franchise (usually family members).
The kit also includes an official corporate seal which is used to validate official company documents and to open a bank account for the business.
In my next article, I will discuss various steps that each franchise owner should take to maintain the legal protection and tax advantages of the corporate status that he (or she) has acquired. A selection of business owners and corporate advisors will be interviewed on how how to best exploit the benefits of incorporation within the framework of the franchise industry.
Have questions? Please call us at (800) 462-4633 (domestic) or (302) 428-1200 (international).
