Picking The Right Business Entity for Going Public

December 3rd, 2008

by Patrick Gibson

When you start a business, you need a plan. Part of the plan should be your exit strategy. For many people, the ideal exit plan is to take the company public and hire professional executives to run it. To do this, you must pick the correct business entity when starting the business.

First things first. A business entity is the structure of the company. It can be a shell entity such as a corporation and limited liability company or something more direct such as a partnership. If you want to go public one day, only one choice will work.

Most businesses today are formed as either a corporation or a limited liability company. They are the most popular because they shield their owners from personal liability for debts incurred by the company such as an office lease.

The limited liability company was first created in Wyoming in the late 1970s. It was part of a package of laws designed to create more business for the state by giving small businesses an entity that provided protection from lawsuits without the paperwork of a corporation.

The limited liability company did not expand much beyond Wyoming until the late 1980s when the IRS issued an amazing regulation. Essentially, the IRS said a limited liability company could be taxed like a partnership, a huge advantage over being taxed as a corporation.

Suddenly, the LLC looked like a super business entity. States rushed to create laws allowing for their formation. Business entity lawyers rejoiced in a golden age and small businesses actually had a business entity that worked.

There is no perfect business entity and the LLC proved to have its problems as well. The IRS did not like single owner versions of the entity. State fees could be atrocious. Only when people started to try to go public did the huge concern arise.

The primary problem with taking an LLC public has to do with how ownership is held. The owners have a percentage interest in the company. To go public, a business must have shares of ownership that can be traded. The LLC has none.

To take a company public, the ownership must be held in shares. Otherwise, how can the ownership be bought and sold on an exchange? This is why you see all large, publicly traded entities with shares and dividends based on shares.

If you want to take your company public one day, you must choose a corporation as the business entity. Any other choice is going to be problematic.

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