CORPORATIONS, LLCs, or PARTNERSHIPS
Play Golf and Put Your Business on the Right Track
As a mini-storage sole proprietor, or, hopefully, prior to beginning your business, you realize you can't handle everything yourself. You need to attract investors, take on a few associates, and protect your personal assets from your potential liabilities. It's time to start running your company in a more formal manner.
The question is should you set up the business as a corporation or partnership? The answer may be neither. There are a variety of choices including a Sole Proprietorship, General Partnership (G.P.), Joint Venture, Limited Liability Company (LLC), “C” Corporation or “S” Corporation. Each of these form should be selected based on your individual financial, tax and liability requirements. Adopting or changing your form of business requires careful consideration of your needs, your business associates, and the legal risks involved.
One word of caution: Many States have different statues governing the way of doing business in that particular State. For a glossary of business legal terms you can search the Internet using key words ‘incorporation law” or ‘business law’. The following are general statements made for the purpose of giving a general overview.
“Assuming that you have a business plan and a good business idea, you’ll want to consider what sort of entity you want to be,” explains Newport Beach, Calif.-based Gil Lasky, Law Office of Gilbert P. Lasky Professional Corporation. You may select either a “C” Corp or an “S” Corp, or if other people are involved, you might choose a LLC.”
“I think the LLC is probably the best form for multiple parties. It has all the benefits of a corporation and yet has favorable tax benefits in terms of passing profits and losses through to the members of LLC, so that they don’t have the problem of double taxation. The essential difference in most entities is one of tax benefits.”
“Critical to the form of your entity,” Lasky explains, “is whether or not you have some plan down the road to go public. Then you might want to consider using a “C” Corp, depending upon the growth prospects of the business and the kind of cash flow and the value of the real estate. There are some tax benefits by eventually turning your “C” Corp into a Real Estate Investment Trust (REIT),” he adds. “The mini storage business throws off a lot of cash, there is very little owner involvement, and it is a very good candidate for going public, especially in the form of a REIT.”
“No matter which form or entity you select,” says Lasky, “if you go into business you will incur some liability. You should have sufficient liability and casualty insurance to cover any losses - even if you have a corporation or an LLC.
Self Education
Like most business plans, yours must include your long-range goals. Check out www.selfstorage.org, the Self Storage Association’s Web site, and you’ll find the Association cautioning “…like any other real estate industry, no one place has all the information necessary to be successful. It is the accumulation of knowledge and continuing education that will best help you make it in self storage.”
No one knows that better than Alan Gamache owner of Sacramento, Calif.-based Self Storage Management Service. Selfstorage@onebox.com. After 16 years working for an assortment of mini storage companies, Gamache is going independent. He spent five years with Seattle, Wash.-based
“I began in accounting, then went to field management and finally became VP of property management and development,” he explains. He knows the financial side, how to work with third party owners, he understands the reporting needs of the owners, and he has field experience running the individual mini storage locations. “I’ve been to school,” he adds. “The LLC is the right entity for me, because it’s an inexpensive way to start your business and it provides a limited liability and the lower amount of taxation.”
“Once your ‘entity’ is formed, you have to put together your entire infrastructure, set up employment agreements, and operations policies. There is a lot of information out there that’s already prepared or in the form of templates. One of the nice things about running your own company is that you can pick and choose the best ownership structure and operations format. It’s all about customization.”
Gamache cautions: “The competition out there is getting tough. As each market becomes saturated, owners will need to have a more focused management. A lot of developers who have no self storage experience are probably going to have to hire an outside manager. I want to fill niche.”
The LLC
An LLC, a form of business organization popular among small business owners, is one that combines some advantages of a corporation and some of a partnership.
Dallas, TX-based Cyndy Montgomery and the Lincoln Financial Advisors specialize in organizing businesses. As a CFP, CPA, McDonald is a Registered Representative of Lincoln Financial Advisors Corp. “LLCs can offer a competitive advantage over corporations and partnerships in three areas: taxes, liability protection, and flexibility,” she explains.
McDonald explains that if the LLC is structured properly, it will be taxed like a partnership for federal income tax purposes. “That means no tax at the company level. Like partnerships, LLCs distribute income and losses directly to owners who then report these items on their personal income tax returns. Being taxed like a partnership also avoids the double taxation problem faced by shareholders in a corporation. Corporate earnings can be taxed twice -- first as income to the corporation, and again as a dividend income to the individual shareholder. This combination of two levels of tax can mean a much higher tax cost than the single tax available through ownership of an LLC.”
“In general or limited partnerships, general partners can be held personally liable for the partnership's debts and obligations, as well as other partners' mistakes -- a big deterrent to many would-be entrepreneurs and prospective investors,” McDonald explains.
“Additionally, in certain situations, limited partners who become actively involved in running a partnership can be reclassified as general partners and lose their limited liability protection. But LLC owners, like corporate shareholders, are shielded from personal liability beyond the value of their investment. Their personal assets are generally not subject to the claims of business creditors. LLCs avoid the threshold problem in forming a limited partnership -- finding a general partner willing to be exposed to the business's liabilities.”
Partnerships
Long Island, NY-based Kenneth Piken, of Kenneth Piken and Associates, is a corporate attorney working as a real estate trial lawyer. He was the first general counsel of the New York State Self Storage Association, and has been around the mini storage business for about 15 years.
Piken explains that the Limited Partnership is historically reserved for professionals like actors, doctors and attorneys. “The entity insolates one partner’s errors from the other, unless it’s an error committed by the firm itself. It is created so that the partner’s assets can not be attached in the event of a court case. For limited partners the tax benefits are better historically than in any kind of corporation,” he adds. “The general partner is the one in control, and generally speaking, the limited partners are investors.”
Piken gives sound preplanning advice: “Plan a protracted meeting with an attorney and an accountant at the same time. The different uses of a facility create greater liability exposure. There is a trade off between profit and potential for liability, as well as the tax consequences.”
“I had a client who did business with our firm for many years. He invited his accountant and his attorney to play golf. When the game was over he had about $10,000 worth of free advice that he didn’t have the day before.” Lesson learned: play golf!
Newport Beach, Calif.-based Mike Linkletter, grandson of TV personality Art Linkletter, is the CEO of Linkletter Development, a General Partnership. The company has been in the mini storage business as Linkletter Self Storage since l970. He uses the General Partnership entity because, he says, “….it allows for the flow-through of taxes.
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Corporate Alternatives
Generally, a corporation is a legal entity owned by people, usually referred to as shareholders or as the "limited liability" of its shareholders. For example, if a corporation files bankruptcy, shareholders are not liable for the debts of the corporation. The corporate entity is responsible for its debts and liabilities, not the shareholders. The shareholders only stand to loose their initial investment.
In some cases the owners of a corporation can loose their limited liability privileges because the courts will "pierce the corporate veil" and treat the incorporated entity as a sole proprietorship or a partnership. This can happen if the corporate entity is basically an alter ego for its owner, or when there is shareholder misconduct, or if corporate formalities are not performed in a timely manner.
A "C" Corporation is the traditional form of corporate entity. It provides limited liability to its shareholders and is subject to double taxation. There are no limitations on the size of a "C" Corporation.
A Close Corporation, as a type of corporation, is also known as a "closely held" corporation. A Close Corporation is generally comprised of a limited number of shareholders, and is usually subject to restrictions on the transfer of stocks that are typically not traded on the major stock exchanges. Most of the shareholders participate in the management therefore the transferability of shares is restricted.
An "S" corporation is a "C" corporation with a special tax designation that allows it to avoid double taxation. A Corporation seeking such tax designation must first satisfy certain qualifications and than file a special form with the IRS.
The main advantages of incorporating are the limited liability of the owners, perpetual existence, ease of transfer of interest by the shareholders, and professional centralized management.
Final Advice
Help of an attorney is not required to form a corporation. However, the complexities of the process make professional assistance highly advantageous. Lack of professional assistance may result in errors and omissions, which could result in serious legal consequences, including the invalidation of the corporate status and loss of the limited liability privilege.
If you have questions about which form of business structure is best for your business, please contact an experienced attorney for legal guidance.
Whatever form of entity you chose, beware, research, and educate yourself. Check with your attorney and CPA -- together. You might try a round of golf with them!
