By: Brandon Shelton
I was sent another great question from our friends in the theatre relating mainly to the benefits and timing of forming an entity around a small voice and speech business. I like this topic a lot, because there can certainly be some benefits to forming a legal entity with your state, but there are plenty of considerations for you to weigh to determine if forming an entity makes sense for your line of work. The specific question was:
“I’m a voice and speech teacher, and occasionally work as a private coach with folks on accents, vocal ease, etc. The work comes pretty irregularly, so as of now I just collect my fee and move along. I’m curious at what point I would want to (or have to) consider a more formal legal structure (sole-proprietor, LLC, etc… not even sure what all the options are!) and what the pros and cons are.”
As an initial matter, it would be good to understand what your options are in terms of actual entities. There are numerous choices for forming entities, though since we are speaking about an individual person engaged in providing services to clients, I will narrow this discussion to three main entity types geared towards providing consulting services: sole proprietorships, LLCs, and corporations.
Consulting Explained
Taking a step back, when individuals provide advisory or consulting services, whereby they assist clients in areas of their business or personal lives according to their expertise in a particular field or line of business, it’s fairly common to refer to the business owner as a consultant or advisor. The difference between the two monikers is not hugely substantive, but many resources basically say that a consultant has a finite task or timeline by which they provide services, and advisors are basically the same thing just with a more indefinite, ongoing timeframe. So a consultant might be hired for a finite period of two months, or through a particular Irish production for example, whereas an advisor is basically on call for all productions until the parties end their relationship. Given this practice, it is relatively common to set up a formal entity through which to provide your consulting or advising services.
Sole Proprietorship
A sole proprietorship is technically not a formal entity that is created with your state. It is more or less in existence as long as you are engaged in providing some services for profit. In other words, you don’t need to file anything with the state or the federal government to be considered a sole proprietor. If you are providing voice coaching services at any time, the state and the federal government is basically going to treat you as a sole proprietor. Given that, there would likely be some requirements for you to report any income you make so that it can be appropriately taxed at either level.
Some individuals like to make the existence of their sole proprietorship a little more professional by giving the business a name and creating business cards and contracts on behalf of the business. However, technically you are only allowed to do business under a proper name of the business (which initially would just be your name). To allow your sole proprietorship to have a nice, customer friendly name, it would be a good idea to establish a fictitious business name (or ‘dba’) with the city or county that you live in. That’s certainly not a requirement, however, as you could simply provide your services under your name as an individual operating as a sole proprietorship, and just make sure you reach out to your CPA to figure out how to report the income you make through your business.
The main drawback to a sole proprietorship, whether or not you have established a dba, is that there is no protection against personal liability for claims against your business. In other words, if you are held liable to a client or a third party, the court could garnish your personal wages, or require you to liquidate your Spiderman comic book collection to pay off any such judgements. I, for one, would not be happy about that. For that reason, many individuals choose to form an LLC or corporation with the state in which they live to protect themselves against personal liability.
As a side note, you will also likely need to file for a city business license in the city through which you provide your services, which is true of any business (sole proprietorship or otherwise) that is doing business for longer than a week. So regardless of which entity you choose, you should at least explore establishing your city business license to ensure you aren’t hit with any fines from your city.
Limited Liability Company
The most common type of entity that we see formed for consulting companies is the limited liability company (LLC). The LLC has a number of benefits, including protection against personal liability, and a relatively easy to maintain corporate structure. With respect to the latter benefit, corporations require annual shareholders meetings where you elect the board of directors. LLCs typically do not have a board of directors (unless they create one), but are rather managed by “managers” who are established immediately and hold their positions until they leave or are replaced by a vote of the members (“members” is simply another word for owners of an LLC).
However, there are definitely some drawbacks to the LLC over the sole proprietorship. In particular, LLCs must pay annual franchise taxes. In California, that number is usually $800 a year. Additionally, if you thought your business might grow into something more than just a one person shop, such that you would like to seek out investors into your company, investors are more likely to invest in a c-corporation due to the flexibility of issuing equity in a corporation. However, consulting companies rarely bring in outside investment, as they are typically vehicles to provide personal services, and aren’t expected to grow into some giant corporate entity. In any case, your main consideration would be whether or not the annual franchise tax is financially viable for your business, which would depend on the litigious nature of your clientele, and the amount of business you are bringing in. If your service is rather docile, and you only make a small amount of annual income through your services, it might not be worth your time and money to create an LLC. However, if you have a lot of work coming in, and you know your clients to be rather volatile and litigious, then it could be worth it to form the LLC to protect your personal assets from liability.
A side note on “piercing the corporate veil”: the “Business Judgment Rule” is a rule that essentially states that, as long as the managers, directors, and officers are using their business judgment to make decisions and act on behalf of the company, a court will not second guess their decision making, unless it is so divorced from reality that nobody in their right mind would have taken such an action, and will protect them from personal liability. However, if they do breach that requirement, and use the company improperly, or fail to adhere to essential corporate formalities, then a court might “pierce the corporate veil” and hold them personally liable for claims.
Corporations
Corporations enjoy similar benefits to LLCs, which mainly relate to limitation against personal liability for claims against the company. Additionally, as touched on above, investors will prefer to invest in a c-corporation due to the greater flexibility in equity. However, the additional corporate formalities generally make this type of entity less attractive to individuals providing consulting services. Given that fact, you would again have to weigh whether or not the expense of franchise taxes and additional formalities is worth your time and money.
One Last Wrinkle: S-Corp Elections
Newer tax rules allow both corporations and LLCs to file s-corp elections, which essentially notifies the IRS that you wish for your entity to be treated as a passthrough entity. As a passthrough entity, certain amounts of your company’s revenue could avoid “double taxation,” where the company pays certain taxes on that income, and then when that income flows to you, you are taxed on the personal income. This can have significant tax benefits to companies if you are bringing in a certain threshold of profit into your LLC or corporation. To determine whether or not this is a good idea, you should always consult with a CPA.
Back to the Specific Question
Based on the question asked in this inquiry, it would be a good idea for individuals providing voice and speech coaches to consider if it’s worth their time and money to form an LLC or corporation, and further to consider whether or not they should file an s-election (which again should be at the advice of a CPA). On the one hand, it could protect such speech and voice coaches from liability if claims are brought against them. On the other, it can be an investment of time and money that might not be worth it. If it does sound worth it, feel free to reach out to an attorney and CPA to further evaluate if forming an entity is right for you.
In terms of deciding when you should actually consider forming, it would again be a judgment call. As the business grows, and/or your personal assets grow, you will likely be more inclined to create some form of legal separation between the two. However, there’s no hard and fast rule as to when that should be. To determine if now is the time, it would be a good idea to check in maybe twice a year to ask yourself: (1) How many clients do I currently serve? (2) How much revenue am I bringing in? (3) How litigious are clients in this field generally? (4) How much value has been built into my personal assets? and (5) Have I heard of any horror stories from similarly situated businesses being subjected to lawsuits through their course of business?
Obviously, some businesses will be riskier than others. For example, on-site construction services probably carry greater risks of physical harm and claims from disgruntled clients than would voice coach consulting services (though feel free to disagree… us theatre folks can be pretty demanding sometimes). Ultimately, it will be a bit of a judgment call to determine whether or not the risks outweigh the costs.
Break a leg! (…But only yours… in fact if anyone’s legs are subject to breaking that often, maybe consider forming the LLC…)
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.