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Start-ups, SmallBusinesses &Legal StructuresWhich legal structure should I pick for my new business?

Business Innovations Legal Clinic

Access to Opportunity

Handbook Series

IntroductionThis Toolkit will provide you general information about the types of for-profit

business entities an entrepreneur can form in Arkansas. Because this is only

general information, the clinic strongly encourages you to consult with an attorney

and a tax professional familiar with this potentially complex area of law before

choosing (or not choosing) a business structure. However, it is a good idea to

review this document

before consulting the advice of an attorney.

This toolkit briefly covers the disadvantages of a Sole Proprietorship and

Partnership, explores the major benefits of having a formalized business

structure, and explains the pros and cons of the C-Corp, S-Corp, Benefit Corp,

and Limited Liability Company.

At the end of each formalized-business-structure section, is a checklist of

questions, prompts, and charts to help you understand each structure.

The information provided in this toolkit is not intended to constitute legal advice; instead, all information,

content, and materials available in this toolkit are for general informational purposes only. Information in this

toolkit may not constitute the most up-to-date legal or other information. Readers of this toolkit should

contact an attorney to obtain advice with respect to any particular legal matter. No reader of this toolkit

should act or refrain from acting on the basis of information in this toolkit without first seeking legal advice

from counsel in the relevant jurisdiction. Only your individual attorney can provide assurances that the

information contained herein – and your interpretation of it – is applicable or appropriate to your particular

situation. Use of this toolkit or resources contained within the toolkit do not create an attorney-client

relationship between the reader and the toolkit authors, contributors, or the William H. Bowen Business

Innovations Legal Clinic. All liability with respect to actions taken or not taken based on the contents of this

toolkit are hereby expressly disclaimed. The content of this toolkit is provided "as is;" no representations are

made that the content is error-free. Updates to this document were made in March 2020.

DISCLAIMER

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INTRODUCTION

Sole Proprietorship orGeneral Partnership:

No Limited Liability: Each owner is personally liable, which means theirpersonal property and money are at risk to creditors, tort, and contractliabilities that concern the business. In other words, there is no legal shieldbetween your business’ property and your personal property.

Any company that is doing business without filing as a business entity with thestate is automatically considered a sole proprietorship (if the business ismade up of just one person), or a general partnership (if the business is made oftwo or more people). Many entrepreneurs are excited to get started and begin operating withoutthinking through these initial questions that detail how responsibilities, liabilities,and earnings will be divided, or disputes will be resolved. While it is possible to start your own business without consulting a lawyer orchoosing a formalized business structure, the Business Innovation Legal Clinichighly discourages this. Without a formalized business structure, several issues canarise if the business owners fail to set their own operating and managementguidelines. While it is possible to create operating and management guidelines fora Sole Proprietorship or General Partnership, few do, and problems can abound.(Note: a Sole Proprietorship being one owner, while a General Partnership involvestwo or more owners; both are unincorporated, default business structures) The following are some of the inherent risks and complications in starting a SoleProprietorship or General Partnership:·

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No Clear Taxation Plan: If the founders fail to establish adequateorganizational guidelines and the business is profitable, there is no statutory orindependently created structure to control how owners will share in the profitor pay income and self-employment taxes. Without such a plan, the business isvulnerable to disputes without a plan of resolution, and without resolution, thebusiness could be forced to dissolve, even if it is generating profit.

No Clear Division of Proceeds: A partnership/sole proprietorship does notrequire a written set of documents that explain how proceeds will be divided. Some business owners contribute to the success of a business more than others,and it is recommended that you pick a business structure that requires you todescribe how proceeds will be fairly distributed before your business entity isup and running. The corporate, and LLC structures require this. Without such aplan, the business is vulnerable to disputes without a plan of resolution, andwithout resolution, the business could be forced to dissolve, even if it isgenerating profit.

No Clear Plan for Dispute Resolution: A partnership does not require awritten set of documents laying out how disputes will be resolved. Creating aneffective formalized business structure can make it clear whose decisioncontrols when owners disagree on a business’ operating strategy. Without sucha plan, the business is vulnerable to disputes without a plan of resolution, andwithout resolution, the business could be forced to dissolve, even if it isgenerating profit.

As you read on, you will find that the effort it takes to choose a formalizedbusiness structure is far outweighed by the benefits and protections it will provideyou and your business.

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The Major Benefits of aFormalized Business Structure:

Limited LiabilityAll formalized business structures protect business owners from beingpersonally liable for common risks involved with running a business relatingto creditors, torts, and contract liabilities of the business. Without aformalized business structure, a business owner’s personal property andmoney are at risk.

Favorable income-tax treatmentThere are two main ways businesses and their owners are taxed, these are“double taxation” and “pass-through taxation.” When you choose aformalized business structure you are also choosing how you and yourbusiness will be taxed; some structures allow you to choose between “pass-through” or “double” while others lock you into one or the other. Choosing aPartnership or Sole-Proprietorship without a clear taxation plan can beburdensome and a source of unnecessary conflict (the next section will giveyou a general overview of the types of taxation and their implications).

Flexible business managementUnder state law, each formalized business structure can be managed in aspecific way. You will want to select the structure that works the best forthe owner’s preference. For instance, in an LLC, the owners are able tomanage the company together and equally. In a corporation, themanagement is handled by the board of directors.

Arkansas’ formalized business structures offer protections and benefits that a soleProprietorship or Partnership cannot. Most entrepreneurs look for three majorbenefits when deciding on a formalized business structure:

Arkansas recognizes four types of structures available to for-profit businesses: 3types of corporate structures, and one limited liability company structure. Thesefour structures each have a unique effect on business owners’ liability, income-taxtreatment, and flexibility of business management. This toolkit will also discuss anadd-on feature called B-Corp: a certification status for businesses that have asocial enterprise feature.

[1] A social enterprise is a for-profit business that has dual objectives: to maximize profit andachieve a socially beneficial goal.

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Corporate Business Structures(S-Corp, C-Corp, Benefit Corp)This section, in a very general way, explores the C-Corp, S-Corp, and Benefit Corp, thethree corporate structures Arkansas recognizes.

General Corporation Features:

The following features are in all S, C, and Benefit Corps, with slight modifications foreach. Owners are Shareholders- Corporations have shareholders who become owners. Generally, corporations make iteasy for others to invest. Also, with some exceptions, the individual shareholder’s legalrisk is limited to the extent of that person’s individual investments. If the corporation isable to make a profit, any income left over will be returned to the shareholders asdividends. Taxation- Dividends of shared shareholders are taxed at a lower rate than income tax, so it is oftenpreferable for owners of a company to be shareholders. Board of Directors and Officers- The board of directors are the managers of the corporation, and the officers are thosewho hold specific titles and duties within the Board. The board of directors deliberate andvote in matters of overall business direction; they also appoint officers who run the day today affairs of the corporation. officers usually include the president, secretary, andtreasurer. In both large and small corporations, officers are often also directors andshareholders. A corporation can also have staff, such as a Chief Executive of Operations or ChiefFinancial Officer. Staff positions are not necessarily board members, but in manycorporations, the members of the staff also happen to be board members as well. It isalso common for board members and staff to be shareholders. Fiduciary Duties- Directors, officers, and staff have duties to serve the corporation and shareholders tothe best of their ability, above their own individual interests. Their primary end-goal is forthe corporation determined by the corporation’s bylaws, and often includes maximizingprofits.

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Number of and type of shareholders. There are no limits to the number of investorsor shareholders your C-Corp has. Shareholders need not be individuals at all, but canbe other business entities as well. Foreign (non-American) investors and shareholdersare also allowed to participate in your C-Corp. There is great flexibility in stockoptions, allowing for preferential investor status and similar arrangements.

Taxation of Income. C-Corps are subject to Double-Taxation, meaning income istaxed first at the corporate level, and again when the income is distributed toindividual shareholders. First, the C-Corp files an income tax return; then, theshareholders receive the remaining income as dividends. These dividends are subjectto personal income tax, but because the shareholders receive the remaining income as“dividends,” it is taxed at a lower rate than ordinary income (e.g., income earned assalary.)

Corporate Formalities- It is important for the Owners to run their corporation “as a business.” This means theymust follow corporate formalities including proper record keeping and board meetings,maintaining a clear separation between the corporation’s actions/transactions and theOwners’ actions. Failure to keep these corporate formalities will cause the corporation tolose its “personhood” and it will be treated as the Owners’ “Alter-Ego”- causing eachowner to be personally liable, which should be avoided if at all possible. Startup Costs and Annual Fees- Corporations require a fee for their initial establishment, along with annual fees andexcise taxes.

Corporate Structures Available in Arkansas The three corporations you can form in Arkansas are a C-Corp, S-Corp, and BenefitCorp. Below are their important differences. It is important to consider each beforedeciding which is for you, if any. For instance, do you intend to attract outside capital foryour business? Or, do you intend to limit management and ownership to just you and afew other individuals? Again, the Clinic encourages you to speak with an experiencedattorney and tax professional before committing to a particular corporate structure. C-Corp- In addition to the general corporation features listed above, a C-Corp is unique in thefollowing ways:

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Taxation of Income. Owners of S-Corps can opt for Pass-Through taxation,meaning, the income of the business is only taxed once after it is distributed to theindividual shareholders. The Corporation is not taxed, and once the shareholdersreceive their dividends, they must report the income on their personal income taxreturns. An S-Corp is a good alternative to those looking to avoid double-taxation, butit comes with strict limitations set by the IRS.

Number and Type of Shareholders. S-Corps must have fewer than 100 shareholders;the shareholders must be United States Citizens and can only be individual, not otherlegal entities such as businesses. Each share of stock must have identical rightsattached to it (one class of stock). This means you can’t have stockholders who havedifferent powers.

S-Corps- The S-Corp varies from the C-Corp in the following ways:

These limitations mean that the S-Corp cannot offer stock options to future investors,investors can only be humans and companies or other organizations cannot invest, theindividual owners’ gains and losses must be proportional to the amount of stock owned.More flexible income arrangements allowed for a C-Corp are not permitted by the S-CorpStructure. Benefit Corp- Some Entrepreneurs may want to make profit while at the same time have socially-valuable goals in mind. These entrepreneurs may be concerned that their goal to benefitthe public will conflict with their fiduciary duties to maximize profit. While these goals canbe included in the bylaws or operating agreement of an LLC (discussed below), theentrepreneur may want to have this socially-minded purpose branded on its legalstructure so that shareholders cannot contest business decisions that are made with thissocial benefit in mind. For this purpose, Arkansas recognizes the Benefit Corp whichallows a business to, in addition to making a profit, create a public benefit. The next page lists the requirements for a Benefit Corp. [2] 26 U.S.C. §§ 1631 (c)(2)(A), 1361 (d).

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BENEFIT-CORP, ARK. CORP. STRUCTURES

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Providing low-income or underserved individuals or communities withbeneficial products or services;

Promoting economic opportunity for individuals or communitiesbeyond the creation of jobs in the normal course of business;

Preserving the environment;

Improving human health;

Promoting the arts, sciences, or advancement of knowledge;

Increasing the flow of capital to entities with a public benefitpurpose; and

Conferring any other particular benefit on society or the environment;

Benefit Corp Requirements- The Founders of a Benefit Corp are required to appoint a Benefit Director and mayappoint a Benefit Officer. The Benefit Director must issue an annual report regardingthe corporation’s compliance with its public benefit mission, and shareholders have theability to enforce that mission. The Following are examples of what Arkansasrecognizes as Public Benefits:

This means that profit maximization is not the only goal of the Benefit Corp, andthus shareholders should keep this in mind when making an investment. [3] A.C.A 4-36-103 (a) (8)

B-Corps:B-Corps should not be confused with Benefit Corps, despite the similarity in name. TheBenefit Corps structure was created by and is recognized by the state through a law. Onthe other hand, a B-Corp a structure that was created by a nonprofit called B Labs. B-Labs is a nonprofit that monitors and provides a formal process for businesses thatwant to be recognized as having a genuine, socially valuable mission. This is a goodoption for businesses in states that do not have a Benefit Corp option, or for Businessesthat want the extra seal of approval of B-Labs in addition to their state. A B-Corpclassification is an alternative means to encourage responsible business practices andcorporate commitment to public benefit. Unlike most states with laws that allow for the creation of a Benefit Corporation, B-Labssets out a set of enforcement mechanisms that allow the investor to determine whetherthe business has complied with its commitment to the social good it claimed to serve in itslegal documents and corporate branding. If a corporation wants to be labeled as a B-Corp, it is subject to random audits by B Labsto ensure its practices comply with the B-Corp Standard. The annual certification fee starts at $500 and is then scaled to a business’ revenueamount. For instance, a business that makes an annual revenue of less than $149,000 willpay an annual fee of $500, while the next revenue tier ($150K- 1.9MM) requires an annualfee of $1,000. To learn more about B Lab’s certification requirements visit:bcorporations.net/certification.

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Articles of Incorporation—The following prompts will help you define the basicoperating elements of your corporation, required in the corporation’s articles.A corporation does not exist until its articles of incorporation are filed with theSecretary of State.

What will you name your corporation?

Remember, this is the name your corporation will use to enter into contracts andmake business transactions.

The name of the corporation must contain one of the following words or itsabbreviation: Corporation (Corp.), Incorporated (Inc.), Company (Co.), orLimited (Ltd.)

What will be the purpose of your corporation?

In addition to the mission statement, will it exist only to maximize profit, or doyou have a social benefit in mind?

Do you want your directors’ and officers’ primary duty to maximize profit, or willyou designate a Benefit Director to focus on your corporation’s interactions withsociety?

Is running a traditional for-profit corporation with a B-Corp classification fromB-Labs more attractive to you?

In what state will your corporation primarily conduct business?

Many corporations incorporate in one state while conducting business in anotherfor several strategic reasons. The clinic encourages you to speak with a businessattorney before making this decision.

Below is a checklist of questions you will need to answer when creating a corporation.

[4] A.C.A. 4-27-1002

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Corporation Checklist (1/9)

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What is the name and address of your corporation’s registered agent?

Arkansas requires that your business has a registered agent. This agent exists toaccept important legal documents on your business’ behalf.

Keep in mind that the registered agent’s information will be on public record andwill be where unfavorable legal notices will arrive. There are registered agentservices if this is something the owners do wish to undertake.

What will be the number of Authorized shares for your corporation?

Will there be different classes of shares? What will be the value of a single sharein each class of shares? If you choose to create classes of stock, how will eachclass differ? Will only some classes of stock enable the shareholder to vote? Willyou set shares aside to give to future employees?

Bylaws— Though they need not be filed with the state, bylaws must be created.Bylaws contain any provision for managing the business and regulating affairs of thecorporation, and cannot conflict with the articles of incorporation. Bylaws usuallyinclude provisions concerning the following: stocks, stockholders, directors, officers,and how to amend the bylaws.

Management and Control— Each corporation should have a board of directors thatmanage the corporation, ensuring it meets its objectives and purposes. The board ofdirectors also decide the duties, roles, and responsibilities of the officers who overseethe day-to-day operations of the corporation.

How will you create your board of directors, and how will they manage yourcorporation? Things to keep in mind:

Directors need not be Arkansas residents or shareholders.

In corporations with fewer than 50 shareholders, the board of directors’authority may be limited, or the board may be eliminated altogether.

[5] A.C.A. 4-27-206[6] See Amendments (pg. 11)[7] A.C.A. 4-27-802[8] A.C.A. 4-27-801 (c)


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How will directors be chosen and how will the business deal with conflicts ofinterest?

It s important that your directors are able to uphold their fiduciary duties andremain independent. (see Fiduciary Duties section)

From a legal perspective, it is preferably that directors not have family orbusiness relationships that create a conflict of interest. IF there are directorswith such relationships, create a conflict of interest policy that lays howdecisions will still be made fairly, without undue power given to the conflictedmembers.

Will you allow directors to use information they received from working withthe corporation in their personal work?

If no initial directors are appointed in the articles of incorporation, theshareholders can elect directors at the initial organizational meeting. Unlessotherwise provided in the articles of incorporation, directors are elected at eachannual shareholders’ meeting. You can decide how long the director’s terms willbe in your articles of incorporation, and your bylaws will determine what eventswill trigger the automatic removal of a director and the process for that removal.

Will your directors be paid? If so, how often? This payment can occur annually,monthly, or determined after services are rendered.

Will your bylaws allow directors or others to conduct business in thecorporation’s name?

Will the corporation indemnify directors? Indemnify means that the corporationwill pay the director for any loss that person suffered by virtue of theirinvolvement with the corporation.

[9] A.C.A. 4-27-803 (d)

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Officers— Officers are elected by the board of directors to oversee the day-to-daytasks of the corporation.

Most Corporations have the following officers:

President - responsible for providing long-term strategic leadership.

Vice President - responsible for making sure the president’s plans are carriedout by overseeing operations.

Secretary - responsible for making sure the corporation operates efficiently andin compliance with statutory and regulatory guidelines.

Treasurer - responsible for keeping financial records and managing thecorporation’s money and financial risks.

Shareholder Meetings— The corporation’s bylaws should say how often theshareholders shall meet and how notice will be given. When deciding on the regularityof meetings, it is important to know that notices must be mailed to each shareholderentitled to vote not less than 10 days and no more than 60 days before the meetingdate. No business can be transacted without a quorum, or a majority of theshareholders present and able to vote. The Board may decide if a quorum is 50%majority or 2/3 majority or otherwise.

An individual may hold more than one office at a time. Officers may also delegatethese responsibilities to staff, like a Chief Executive Officer (CEO) or a CFO (ChiefFinancial Officer). These staff positions are often also Board Members, Officers,and shareholders, but it is not a requirement that they are.

[10] A.C.A. 4-27-705[11] A.C.A. 4-27-725

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Meetings in General— Unless the Articles of Incorporation or Bylaws state otherwise,the Board may take action without a meeting if all the directors consent to the actionin writing. However, at least one meeting per year is required by law. The Clinicsuggests that your corporation’s annual meeting between both shareholders andboard of directors be held at the end of the fiscal year to determine if all requiredcorporate actions were completed during the fiscal year and to prepare anynecessary audits or reports.

Some typical corporate actions include: authorizing bonuses to officers,contributions to profit sharing/pension plans, and declaration of dividends (Ifapplicable).

Other issues discussed at the annual meeting often include: election of directorsand officers, management reports, amendments to the bylaws, any other businessmatters, extraordinary or otherwise.

Shareholder Agreements— Typically, stock is freely transferable, meaning it can befreely sold to anyone. To prevent “outsiders” from acquiring shares in the corporation,some corporations require that shareholders enter into agreements that prohibit thetransferability of stock under certain circumstances (death, disability, disagreement).

Such restrictions may require:

The corporation to first approve the sale of stock.

The shareholder to offer the corporation an opportunity to buy back the stock.

The corporation to buy back the stock from the shareholder when theshareholder wishes to sell.


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Record Keeping- In addition to director and shareholder meetings, and achieving thecorporate goals outlined in the articles of incorporation,

It is important to designate someone who will retain possession of the corporaterecords and where they will be kept.

The bylaws should determine how much notice a shareholder needs to give beforeinspecting the corporation’s records.

A corporation should also maintain the following records:

Minutes of ALL its meetings between shareholders and board of directors

Records of actions taken by the board of directors without a meeting

Records of actions taken by committees of the board of directors

Articles of incorporation, bylaws, and any amendments or restatements

Resolutions adopted by the board of directors

All written communications to shareholders within the past 3 years

Names and business addresses for current directors and officers

The most recent franchise tax report

Accounting records, which include:

Register receipts; bank statements; canceled checks; invoices; shareholdercontributions; income and expenses; federal, state, and local tax returns.

[12] A.C.A. 4-17-1601

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Corporation Checklist (7/9)Shareholder Changes—The corporation’s bylaws may provide for specific triggeringdates or events that automatically add shareholders to the corporation. In addition tothe bylaws, you can draft shareholder agreements that limit what shareholders cando.

Will you allow additional shareholders to be admitted to the corporation? This hasthe effect of diluting the power of existing shareholders and should be consideredvery carefully.

What vote would your bylaws require to admit an additional shareholder?

If a shareholder wants to withdraw from the corporation, must that shareholderget consent from the other shareholders or directors? What vote is required to giveconsent?

What will the notice requirements be for a shareholder who wants to leave, ifany?

What other contingencies should you prepare for before entering into ashareholder relationship?

Death. The death of a shareholder can have serious consequences for yourbusiness. A common solution to this issue is a mandatory purchase or saleprovision.

Stalemate/Dispute. Disagreements about how a business should be managedmay occur, and shareholders and owners may not be willing to compromise. Onemechanism is a forced or voluntary buy out. Buy out clauses should be carefullydrafted by an attorney.

Will the corporation charge shareholder fees or dues? If so, how much will thosefees or dues cost?

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Corporation Checklist (8/9)Amendments— A corporation may need to amend its articles of incorporation or itsbylaws from time to time. This can be done by filing amendments with the Secretary ofState’s office. Typically, Amendments are adopted when a proposal for an amendmentis made by the board of directors and the Shareholder’s approve of the proposedamendment. The following are exceptions where the board of directors can adopt anamendment without Shareholder approval before shares of stock have been issued tothe shareholders, and for the following reasons. To extend the life of the corporation,To delete names and addresses of former director, To delete names and addresses offormer registered agents, To change the corporate name by replacing it with a similarword, or (“Corporation,” “Inc.,” “Limited,” “Company,” etc.)

Dissolution— In Arkansas, there are three ways a corporation can be dissolved.Dissolution is the process by which the corporation’s structure is broken down and isno longer a legal entity, ceasing to exist.

Method #1: Voluntary Dissolution:This is the most common method of dissolution.

If shares have not been issued the board of directors may approve thedissolution; If shares have been issued, the directors must recommendthe dissolution to the shareholders who will vote to approve it.

After dissolution, the corporation can still operate, but only for the purposes ofwinding down. During this dissolution period the corporation may:

Collect its assetsDispose of properties (through sale or any other method of liquidation)Pay off its debts and liabilitiesReturn the remaining property to its shareholders

[13] A.C.A. 4-27-1003[14] A.C.A. 4-27-1002[15] A.C.A. 4-27-1401[16] A.C.A. 4-27-1402

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Corporation Checklist (9/9)Method #2: Administrative Dissolution:

If the corporation fails to pay or file franchise taxes, fails to pay penalties,does not have a registered agent, fails to notify a change of registeredagent, or the corporation’s period mentioned in the articles of incorporationexpires, the Secretary of State can dissolve the corporation.

Method #3: Judicial Dissolution:If a corporation has committed fraud or abused its legal authority, or for anyof the specific reasons stated below, the Arkansas Attorney General canbring a judicial action to dissolve the corporation.

The following are grounds for Judicial Dissolution:

The directors and the shareholders cannot resolve a deadlock and there isa threat of irrevocable injury if the issue is not resolved

The directors have acted fraudulently or illegally

The shareholders have failed to elect directors for two consecutive annualmeetings

The corporation’s assets are being wasted or misplaced

The corporation is insolvent and still owes creditors

A corporation is insolvent when:it can no longer pay its debts when liabilities outweigh total assets

[17] A.C.A. 4-27-1420[18] A.C.A. 4-27-640 (c)

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Limited Liability CompanyBusiness Structure (LLC):

General— LLCs are relatively new business structures, and were first created in 1977in Wyoming, but since have been nationally recognized for the last fifteen years. LLCsare formed when the articles of organization are registered with the Secretary ofState.

Members and Managers— LLC owners are typically not shareholders, but insteadare called members; members own the assets of the LLC, much like shareholders of acorporation. Members are added to the LLC by acquiring interest in the LLC. You cangovern how potential members acquire interest in your Operating agreement or allowthe default state law to govern (by written consent of all members).

Operating Agreement— Members arrange their rights and duties by creating an“Operating Agreement.” This agreement governs all member’s rights andresponsibilities, including how the LLC will be controlled and managed. It has the samefunction as the bylaws of a corporation.

Limited Liability— Much like the corporation, a member’s liability is capped at themember’s investment into the business, protecting their personal money and property.

Fiduciary Duties— Like corporations, managers have fiduciary duties. Managers havea duty to act in good faith, with ordinary care, and with a reasonable belief that theiractions are in the best interest of the LLC. A manager will not be liable for negligentactions or for the failure to act on behalf of the LLC; these duties can be modified inthe operating agreement.

Managers operate the same way that directors and officers of a corporation do: theymanage the LLC. Members and managers need not be individuals or United Statesresidents. An LLC can be managed by all of the owners, just one of the owners, or anoutside entity.

[19] A.C.A. 4-32-206(a)[20] A.C.A. 4-32-801

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Name the LLC: You will need to make sure that your name is unique in the state andregion in which you are using it. For Arkansas, you can check here:www.sos.arkansas.gov/corps/search_all.php.

Choose a registered agent: This the individual who, among other things, will beresponsible for receiving any sort of legal document.

Create an Operating Agreement: This is the document that provides the basis andprocedure by which the LLC will operate generally, including deciding major issuesand solving problems.

Create and File the Articles of Organization: The articles are the bare minimum ofwhat the Secretary of State requires to be a registered LLC. You will need to be aregistered business to obtain an EIN from the IRS. For Arkansas, you can file here:www.ark.org/sos/corpfiling/index.php?form_id=13.

LLC Disadvantages: The LLC enjoys the management flexibility of the C-Corp while benefiting from pass-through taxation, but there are two disadvantages to the LLC structure that may not bebest for some business owners:

Because the LLC is relatively new, its flexibility has not been adequately tested incourt. And there is little law established about how members of an LLC will be heldliable for conduct that violates the structure. This may make some hesitate to invest,and angel investors may require the LLC to convert to a corporation.

Owners within the LLC structure will be subject to Self-Employment tax and, if theowners also work as staff of the business, they will not be able to separate the moneythey have earned as owners from money they have earned as employees. In an S-Corp, employee/owners can separate their salary (which is taxed at the income-taxrate) from their dividends (which are taxed at a lower rate). In some situations, an S-Corp Owners can receive more after-tax income than LLC Owners.

It is important to discuss the complex tax implication of an LLC with a tax professional ortax attorney to make sure an LLC is best for you.

Steps to form your LLC:The following is a list of steps you can take to form a successful LLC:

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Obtain an EIN from the IRS: You will need an EIN to open a bank account. You canapply for one online here: https://sa.www4.irs.gov/modiein/individual/index.jsp.

Open a Bank Account: Call a bank to determine what documents they require inorder to open an account. At minimum, they will request proof of EIN and a Certificateof Good Standing from the Secretary of State.

Reporting System: Develop an annual reporting system and establish a locationwhere all records for the LLC will be kept. You should include the following: director’sreport, auditor’s report, balance sheet, income statements, lease agreements, bankaccounts, legal agreements, insurance policies.

Register for Sales Tax: Review this website to determine if this applies to yourbusiness: https://atap.arkansas.gov/.

Obtain Licensing and Permits: Review this website to determine if this applies to yourbusiness: www.sba.gov/business-guide/launch-your-business/apply-licenses-and-permits.

Insurance: It is strongly recommended that you obtain insurance for your LLC. Thismay include general liability insurance, worker’s compensation insurance, volunteerinsurance, malpractice insurance, or vehicle insurance. For more guidance, reviewthis online article: www.forbes.com/sites/thesba/2012/01/19/13-types-of-insurance-a-small-business-owner-should-have/#759c32fc20d3.

Hire Employees: If you hire employees, don not forget to decide a system topay employment taxes, health insurance, worker’s compensation, and other relatedexpenses.

Pay Franchise Tax and File Audit Report: (Annually) To keep your businessregistration current, you will need to complete and file a brief report and pay anannual fee referred to as a “franchise tax.” You can do this online:www.ark.org/sos/franchise/index.php.

Steps to form your LLC: (Cont'd)

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Articles of Organization- The following prompts will help you define the basicoperating elements of your LLC. An LLC does not exist until its articles of organizationare filed with the Secretary of State.

What will you name your LLC?

Remember, this is the name your corporation will do business as, entering intocontracts and making transactions.

The name of the corporation must contain one of the following words or itsabbreviation: Limited Liability Company, Ltd. Liability Co., Ltd. Co., L.L.C., L.C.,LLC, or LC.

In addition to your LLC’s name, you will also need to include the following in yourArticles of Organization:

Street Address for the LLC

Signature of the person founding the LLC

You will need to decide who will have the power to manage the LLC; will it be asingle manager, several managers, or will members of the LLC have the power tomanage the LLC?

You can also choose if you would like to be taxed like a C-Corp (“double” taxation),or as an S-Corp (“pass-through” taxation).

You can amend the Articles of organization by filing articles of amendment with theSecretary of State.

Below is a checklist of questions that need to be answered to create an LLC operatingagreement. A well-thought out operating agreement will prevent litigation and provideguidance on how to proceed both before and during disputes.

[21] A.C.A. § 4-32-206(a)[22] See Management, Control, and Voting (pg. 18)[23] A.C.A. 4-32-203(a)

LLC CHECKLIST, LLC STRUCTURES

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Written Operating Agreement- Arkansas requires that your LLC’s operatingagreement be in writing. Operating agreements govern all member’s rights andresponsibilities, including how the LLC will be controlled and managed. It functions thesame as corporation bylaws do.

Operating Agreements Typically contain:

A description of the rights and duties of each member

An explanation of how the LLC will be managed and by whom (Managers orMembers)

A listing of the managers

A plan of how profits and losses will be distributed to the members

A plan for Dissolution

A description of what happens to a member’s interest in the LLC when themember leaves the LLC

Management, Control, and Voting- Managers are the individuals who make day-to-day decisions ranging from what contracts the LLC enters into and what kind of workthe LLC performs. Some actions may require voting by the members and/or managers.You can lay out your voting rules in your LLC’s operating agreement, or let the defaultArkansas statutes govern your LLC’s voting procedures.

[24] A.C.A. 4-32-103(a)

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Management, Control, and Voting (Cont'd)-

Unless you state otherwise in the operating agreement, a manager may be electedor removed by a vote or consent of more than one-half (1/2) of the members.

By default state law, any management decisions are made by a vote of morethan one-half (1/2) of the LLC members.

You may want voting power to be based on the percentage of ownership ofeach member instead of by head count.

You can also list any instances when a unanimous vote by all members ormanagers is required.

Unless otherwise stated in your operating agreement, an act outside theordinary course of business may be taken only with the consent of all theowners.

Default state law already provides that a unanimous vote to allow amanager or member to do any act that contravenes the LLC's writtenoperating agreement is permissible.

Some LLC operating agreements require a unanimous vote before:

The purchase of a piece of property

The acceptance of a new member

The removal of a member

[25] A.C.A. 4-32-401(b)[26] A.C.A. § 4-32-403(a)[27] A.C.A. § 4-46-401(j)[28] A.C.A. § 4-32-403(b)(2)

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Management, Control, and Voting (Cont'd)-

Be sure to list the people you would like to give management authority (members ormanagers)

Name and Address

Contribution to the LLC (money or services)

The amount of that person’s interest in the LLC (expressed as a percentage)

A description of that person’s voting rights, if any

A description of that person’s role and responsibilities to the LLC

If you wish to specify, list additional powers that members or managers withmanagement authority may have in addition to handling the daily operationsof the LLC.

You can limit the authority of managers to conduct business on behalf of theLLC. Default state law allows managers to buy, sell, and mortgage and LLC’sassets.

It is important that your managers are able to uphold their fiduciary duties andremain independent. (see Fiduciary Duties Section)

Managers should not have family or business relationships that create a conflictof interest.

Will you allow Managers to use information they received from working with thecorporation in work that is separate from the business?

Unless you wish to state otherwise in the Operating Agreement, default state lawrequires a vote of more than one-half (1/2) of members to amend the operatingagreement.

[29] A.C.A. §§ 4-32-401(b), -702(a)(1)[30] A.C.A. 432-206(a)

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Dissociation- A person ceases to be a member of an LLC when an “event ofdissociation” occurs. An event of dissociation is simply a specified event that triggersthe removal of a member. You may create your own events of dissociation in your LLCoperating agreement. Arkansas recognizes the following events of dissociation:

The member voluntarily withdraws;

You can require in your operating agreement that consent be required from theother LLC members before a member can resign.

The member is removed in accordance with the operating agreement or anassignment of all his or her interest by a majority vote of the members;

The member becomes bankrupt;

The member dies or becomes legally incompetent;

If the member is a trust, when the trust terminates;

If the member is another LLC or corporation, when the LLC or corporationdissolves; or

If the member is an estate; when the entire estate is distributed.

Transfer of Membership Interest- Unless the operating agreement states otherwise,members are free to assign their interest in the LLC to a third party, but unlike sharesof stock in a corporation, merely owning interest in an LLC will not make you a member(unless stated otherwise in the operating agreement). This means that anyone whoreceives all or part of a member’s interest will only have the right to receive thedistributions from that interest and will have no voting rights or management authority.One who has been assigned an interest in the LLC can only become a member after allmembers approve (unless stated otherwise in the operating agreement).

[31] A.C.A. § 4-32-706(b)[32] A.C.A. § 4-32-802[33] A.C.A. 4-32-706

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Profits and Losses- Your Operating Agreement should specify how the company’sprofits, losses and distributions will be distributed to the members. Distribution is theprocess by which members of the LLC realize the return on their investment. Once amember is entitled to a distribution, he becomes a creditor to the LLC until thedistribution is paid out.

Record keeping- Records related to the creation and management of an LLC shouldbe kept to help monitor the business’ progress and comply with state tax laws. Thefollowing is a list of records and information that the must be kept at the LLC’sprinciple place of business:

A list of each current and former manager and member and their addresses;

Articles of Organization and Operating Agreement, along with any amendments;

The LLC’s tax returns and financial statements for the last three years. Thesedocuments include:

Register, Receipts, bank statements, canceled checks, invoices

Federal, State, and Local Tax returns

Income and expenses

Member contributions

In addition, the following records should be given to members or managers at leastannually:

Income and expenses

Member contributions

[34] A.C.A. § 4-32-604[35] A.C.A. §4-32-405

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FOR-PROFIT BUSINESS ENTITY FLOWCHART

BENEFIT CORP

YOU WILL BE REQUIRED TO ELECT A BENEFIT DIRECTOR

AND DESIGNATE YOUR PUBLIC BENEFIT PURPOSE

IN YOUR ARTICLES OFINCORPORATION.

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For-Profit Business Entity FlowchartDo you want to limit personal liability for your business's obligations and actions?

Is it important that your business receives pass-through taxation?

Is it important that you have the maximum management flexibilityover your businesses' affairs?

GENERAL PARTNERSHIPOR

SOLE PROPRIETORSHIP

THE CLINIC STRONGLY DISCOURAGES

THESE STRUCTURES

C-CORP

A C-CORP IS SUBJECT TO DOUBLE TAXATION

Will you be working as an employee of your business, receiving

both a reasonable salary and dividends from it?

S-CORP

Do you want to be branded as a socially beneficial enterprise?

Do you want a structure that ensures yourcommitment to a social benefit?

Would recognition as a socially beneficial corporation suffice?

B-CORP DESIGNATION

YOU WILL SUBJECT TO RANDOM AUDITS BY B-LABS

Will you eventually wantto issue stock?

LIMITED LIABILITY COMPANY

DEPENDING ON YOUR BUSINESS'S ABILITY TO TURN A PROFIT, YOU MAY END UP PAYING

MORE IN TAXES THAN YOU WOULD UNDER THE

S-CORP STRUCTURE.

YES

YES

YES

YES

YES

YES

YES

NO

NO

NO

NO

NONO

NO

NO

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Have More Questions?

CONTACT Professor Kim Vu-Dinh,

Director of the Business Innovations Clinic(501) 916-5468 [email protected].

CONTACT INFORMATION

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