Webinar Recap: Entity Formation for General Business and Real Estate Entities
Thinking of forming a new venture? Our February webinar (full video below) offered a quick overview of the different types of business entities and takes a specific look at real estate formations.
A quick reminder before we dive in: Choosing the right business entity isn’t just a legal decision. We strongly recommend that you consult with them before making decisions on these matters.
Types of Business Entities
Limited Liability Companies
There are three kinds of LLCs. The simplest is the single-member/sole proprietor. A managed LLCs has more than one member and a member or outside manager. A Professional LLC is common in law and accounting, for instance. Every member of a PLLC must be licensed in that profession.
Requirements for Creation:
A certificate of formation
An operating agreement (not required in Washington, but still recommended)
An Employer Identification Number (EIN) if you plan to get a bank account or hire employees
Upsides: The administrative load is light, it may be taxed as a pass-through entity, and the structure is flexible so you can draft business rules to meet your needs. You can have an unlimited number of members, including non-U.S. citizens/residents and issue multiple units. LLCs can have subsidiaries, and be owned by other corporations, LLCs, partnerships or trusts.
Downsides: There are two main knocks against LLCs, they are hard to convert to corporations and venture capitalists (VCs) and other investors tend to stay away from LLCs.
S-Corporations
An S-corp is taxed separately from each shareholder and income can be passed directly to them.
Requirements for Creation:
Corporate bylaws (rules the company abides by)
Shareholder agreements (rules the people abide by)
Issuance of shares of stock
An EIN
Upsides: VCs and other investors favor S-corps, and they are easy to convert to C-corps when needed.
Downsides: S-corps are limited to 100 shareholders, who must be U.S. citizens/residents, and one class of stock. They cannot be owned by other business entities.
Key issues for Real Estate Entities
There are some special considerations specific to real estate entities.
Before you decide to form a real estate entity, check with your CPA first. Once you have their recommendations, check with your attorney about things like due-on-sale clauses and other terms that can impact your liability.
The LLC is the most common in real estate, but your CPA may recommend an S-Corp if you have employees, which is most often the case for a property management group. Property management LLCs manage a portfolio of properties, each of which is owned by a separate LLC. This structure protects the entire portfolio from debts or liabilities incurred by an individual property. Banks favor single-purpose entities because they don’t want any previous liability to impact the creditworthiness of another LLC.
In addition to the required documents for entity formation, real estate groups should have a formal management powers document for property management groups, a well-defined development plan and budget, and clear competition provisions. It’s also vital to understand waterfall provisions for LLCs with multiple members.
We hope this quick overview helps you understand your options for business formation. You can view the full webinar below.
If you don’t have a CPA, we’re happy to recommend trusted professionals we work with. And reach out if you need more information on legal considerations.
Please stay tuned and join us in March for our next webinar.
