A Solid Foundation: The Importance of Business Structure for Agribusiness Innovator Entrepreneurs
Benjamin Franklin famously said, “There are only two certainties in life – death and taxes.” For agribusiness entrepreneurs, choosing the most appropriate business structure may reduce the latter of life’s certainties. The business structure not only affects the amount of taxes paid, but also establishes the level of personal liability, establishes recordkeeping requirements, and delineates the investors’ role.
Personal Liability and Taxes
Just as there are two certainties in life, there are two predominant considerations when choosing a business structure: personal liability and taxes. Historically, a business owner could minimize one, but not the other. A sole proprietorship or a partnership minimized taxes because the income “pass-through” the entity to the owner or partners, leading to income being taxed only once. However, the owner or partners faced unlimited personal liability for the entity’s obligations. Forming a corporation eliminated personal liability because a corporation exists as a separate legal entity and is responsible for its own obligations. Except in a few rare instances, only a shareholder’s investment is at risk. While a corporation provides limited liability, it also results in double taxation. The corporation pays taxes on its income and shareholders pay taxes on dividends paid by the corporation.
Eliminate Double Taxation through an S-Corporation
Entrepreneurs forming a corporation can elect to be taxed as an S-Corporation. While S-Corporations eliminate double taxation, they may have no more than 100 shareholders and may issue only one class of stock. In addition to the limited number of shareholders, shareholders must generally be individuals, who are U.S. citizens or green card holders. This limitation can later create problems if a company seeks outside institutional investors.
Flexibility with Limited Liability
Beginning about twenty years ago, states authorized creation of limited liability companies (LLCs). Today, LLCs provide agribusinesses with limited personal liability and the ability to elect “pass-through” or corporate tax treatment. LLCs also provide entrepreneurs the opportunity to create a flexible business structure that meets
Common Business Structures for Agribusiness Innovators
The following chart provides a snapshot of some of the common business structures and their key characteristics.
No One Size Fits All
Today, if a business will not be operated as a sole proprietorship, it will likely be organized as an LLC. However, there is no “one size fits all” solution and despite their flexibility and popularity, LLCs are not always the best fit for an entrepreneur’s needs or tax situation. For example, LLCs cannot deduct fringe benefits and the members are subject to higher FICA and Medicare taxes. The members must also pay taxes on the LLC’s income regardless of whether cash is actually distributed to them. Other issues that entrepreneurs should consider include industry norms and expectations, regulatory considerations applicable to the specific agricultural business, as well as the management and equity structure, ease of equity transferability, desired transfer restrictions, means for dispute resolution and cost of dissolution. The ultimate selection of a business structure depends on the business owner’s plans and expectations.
The Impact of Business Structure on Funding
The final, but important consideration when choosing a business structure, particularly for innovation companies, is funding. Start-up businesses usually raise funds through a combination of debt and equity. Debt, especially in start-up businesses, will likely require granting security to the lender and the members personally guaranteeing the debt if it is not obtained from family or friends. Debt also must be repaid, which can reduce cash available for investment in the business or require additional funding.
Alternatively, the business may sell equity to investors. Typically, in a start-up business, there are no mandatory payments associated with equity, but the founding entrepreneurs reduce their share of business’s future profits and their decision making authority. At the same time, outside investors may bring experience and specific expertise to the founding entrepreneurs.
At the end of the day, the decision as to the type of entity and funding structures can be complex. It is important for agriculture entrepreneurs to consider the pros and cons in light of their specific business and growth plans. However, they do not need to analyze these considerations alone – experienced counsel can help guide them through the process to provide a solid foundation for innovation and growth.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.