Business Articles - Legal and Insurance

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Contractors have wrestled with the proper legal structure for their company for years. There is no hard and fast conclusion that works for everyone. There are, however a few things to consider and review that may make the decision easier.

As you read, keep in mind that I am not an attorney and this is not legal advice. It is thoughts from a Better Business Bureau certified arbitrator and one who also does a lot of expert witness and coaching work in the construction industry. What I see sometimes makes me wonder why anyone would want to own a construction company.

I always try to look at things from a contractor's point of view, rather than looking at it from an attorney's or home or building owner's perspective, and so my thoughts here are from that point of view.

Let's take a quick look at the options and I'll throw in some comments on each.

Sole Proprietorship
This is the method chosen by most new businesses to get up and rolling. There is, however, no difference between you and the company or your personal or business assets. Additionally, this method offers virtually no legal protection for you from lawsuits, creditors, or mad ex spouses with a vendetta. That means if you are sued, both you and your company are open to attack and both your personal and business bank accounts become the target.

Partnership
This is where two or more people get together and try to do business under the umbrella of a "partnership". The legal aspects of the partnership are whatever the partners want it to be. My father used to say, "The worst ship that ever sailed the seas is a partnership." His observations doing business from the 1940's to 70's are about the same as mine from 1969 through today. Few partnerships are ever fully defined on paper and fewer still designate a "managing partner" to run the company. Both of these are absolute musts.

So, if you are going to do a partnership or are in one now, be sure that you have a written contract on how the company is set up, how it is to be run and by whom. If you don't, you almost certainly will end up in a disagreement at some point in time.

"C" Corporation
The "C" corporation rules must be followed if you wish to remain bullet proof. If you follow the rules, you are reasonably well protected. If you have been in this business more than a week, you already know how important that can be.

The "C" corporation does have a downside and that is double taxation. The corporation is taxed on income and if you take a dividend (pay, salary, bonus) then you are taxed personally on that amount.

These corporations cost more to set up and so are not as common among small construction companies. Too many contractors fall into the trap of trying to save a nickel when they establish the legal entity under which they will work, so they ask their attorney to set them up as cheap as possible. I will comment more on that towards the end of this article.

The double taxation issue prompted the development of the Sub "S" Corporation.

Sub-chapter S Corporation
The S corporation structure is almost the same as the "C" corporation. The major difference is that the individual shareholders (members) are taxed directly for the profit/loss of the corporation, the corporation itself does not pay any tax. This eliminates double taxation.

L.L.C.
The Limited Liability Company has gained popularity since its inception in the early 1980's. I see more and more companies set up under this flag. I have been told by several attorneys and CPA's that LLCs are the answer to small business prayers. The LLC provides the pass-through profit or loss quality of the "S" corporation and the protection of a "C" corporation. The partners or members of the LLC are not held responsible for any company issues. Hooray!

There are some downsides here, however. When an LLC is setup, it normally has a limited lifespan. It takes a skilled attorney to draft the LLC so that it continues a perpetual existence.

More important is the liability issue, and here is where doing your own research may "save the farm". I have been told by several very good attorneys who focus only on construction issues, that the LLC will not give you the protection you need in today's litigious society. As one of them said to me, if you are developing a piece of land with one or maybe two partners and you are going to develop and then sell the lots, the LLC will work fine.

If, on the other hand, you are doing residential remodeling and you work on a home that has existing EIFS (synthetic stucco siding) or you live in a wet climate, even a "C" corporation may not protect you.

So, where should you be? Here are some things to consider:

• The amount of liability you are willing to assume
• Your management style. If you need to make your own decisions, by yourself, don't consider a partnership.
• How much structure you want. A sole proprietorship has little structure - any corporation has much more. The LLC stands midway between sole proprietorships/partnerships and corporations.
• The level of professional support you have. Any corporate structure should properly be handled by an attorney, and a corporation will require a separate tax return so an accountant?s assistance is recommended.

Finally, let me add this comment for those who have read this far and decided that it isn't worth spending any more time on. When you work on a home or building, there is an implied responsibility to almost everything you do. There are just too darned many ways that we can be sued by our potential or existing customers. Don't think about whether or not you can afford to make your company bullet proof - think about what it will cost you if you aren't bullet proof. Are you smart enough to do it before someone levels their cannons at you? Worrying about the cost of getting a proper legal structure for your company is like asking for the lowest bid from a heart surgeon.

Talk to both your CPA and your attorney. Find out where you can get the maximum protection and get after it. There is no such thing as being 100% bullet proof in this business and there have been a whole bunch of contractors that worked on homes and buildings that had EIFS, mold, lead based paint, or asbestos problems that have found this out the hard way.

Get your legal structure in order and know that you can sleep at night.

By Michael Stone

Michael Stone has more than three decades of experience in the building and remodeling industry. Michael offers Coaching and Consulting services for construction companies throughout the U.S. He can be reached by e-mail at michael@markupandprofit.com, by phone at 1-888-944-0044, or on the web at www.markupandprofit.com.