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Since I quit practicing law and full time development and LLC study, I’ve been personally privy to far fewer situations that demonstrate the LLC’s superiority over the Corporation or Partnership entity structures.  Sure, I have plenty of case law to show demonstrate my points, but it is nice to get a real situation sometimes.

The LLC Protects You Against The Schmuck Factor

My neighbor is a one third member in a meat wholesale business (yes, the $300 box-o-meat that is too big for your freezer).  She and her brother both put up capital — she for the trucks, and her brother for the deep freezer (meat comes in palates, hmmm).  What about the other guy (we will call him Guy).

Guy is a high school buddy of her brother.  He has successfully put nothing into the business and is assumed to have 1/3 ownership.  This guy now wants my neighbor and her brother to convert the LLC to a corporation.  He notes the corporation (and he of course sited the Nevada Corporation), gives better protection and greater tax breaks.  Aaaaaggghhh!  Who keeps perpetuating this junk??!  So lets review what we have written already here on STARTright Talk as to why a conversion would not only be a useless, but a dangerous change.

Why Guy’s “Convert The LLC To A Nevada Corporation” Suggestion Is Flawed

There are three main areas where a conversion in this situation would not only be an unnecessary idea, but a bad one. Those three are 1) Corporation holds no tax advantage over a Limited Liability Company and they are immediately boxed into the more complex corporate tax structures. 2) The corporate veil for a Utah LLC provides equivalent protection for that of a Utah corporation and the Nevada Corporation is not superior. 3) A corporation to LLC conversion would ensure the schmuck walked away with a third of the company for nothing and would open the door to all his creditors.

1. A corporation offers no tax benefits over a corporation.

I have discussed the Federal check the box tax laws, the flexibility of LLC tax and discussed how Utah LLC tax Law follows the federal check the box system.  A suffice it to say here, that she and her business partners/members could choose any style of tax they wanted and yet under their LLC structure.  If they switch to a corporation, they lose the most important option - partnership tax structure - which is the one they currently operate under and understand.

2. A Corporation Does Not Offer Superior Protection To An LLC

I have also discussed the supreme double protection of the LLC on Talk.  In this situation, if they were to convert to a corporation, anyone who sued Guy (the Schmuck) would be able to get at his shares and then have his 1/3 management vote.  Bad idea.  In an LLC, members are protected from an unwanted partner by statutory and operating agreement provisions that make the membership management rights non-transferable even to courts unless the other members consent. Default is 100% consent.

3. The Schmuck Would Ensure Himself His Whole 1/3 Of The Pie

The worst part about this conversion is this however.  These guys like many businesses are operating by the seat of their pants and do not have an operating agreement. Because of this, they are dependent upon the Utah State LLC Act to tell them their membership rights.  In all cases, LLC acts generally bestow membership according to contributions made or capital invested.  No contribution? No membership!  This would be her best way of insuring that this Schmuck did not end up with a third of the profits or liquidation value when he has paid nothing into it.  If they convert to a corporation, ownership is determined by shares.  Whether in hand or on a ledger, shares are shares regardless of contributions.  This means he gets a whole lot of something for nothing.

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