Inc. or LLC?  Which One is Right for Me?

by Donald R. Simon, Esq.

Originally published in Screen Magazine, May 31, 2004, at 12.

Recently there has been an upsurge in the number of production companies using the limited liability company ("LLC") as the corporate form instead of the traditional corporation.  Few, however, know the real differences between an LLC and a traditional corporation.  This article delves into those differences and discusses some of the advantages and disadvantages of both.

A film or music production business requires a corporate form that is both flexible and allows for the accumulation of investment funds--but it also must protect from liability.  The simplest and least expensive business structure is the traditional corporation.  In Illinois, the filing fee for the articles of incorporation is $150.  Throw in at least another $25 for the franchise tax and you’re just about ready to go.  You’ll still need to draft bylaws and a shareholders agreement as well as issue stock certificates.  Forms for most of these items can be found at an office supply store.  An attorney should be able to take care of it all for $400 or $500.

It is important to remember that you may lose your protection if you do not maintain certain corporate formalities like filing annual reports with the state and holding periodic shareholders’ meetings.  You must also keep a sufficient amount of capital in the business and pay all applicable federal and state taxes.  Speaking of, one can elect to have the corporation designated an "S-corp." by the IRS, which allows for "pass-through" taxation. In other words, the corporation is taxed as a partnership or sole proprietorship with profits taxed at the individual rather than the corporate rate.

One of the biggest problems with a standard corporation is that, at least in small companies, the amount of control over the corporation generally follows the amount of money invested.  Here one may face the problem of giving up control to investors who will want an ownership interest.

One solution to the ownership/control problem found in the traditional corporation is the LLC, a structure that enables the producer to raise money from investors or "members," while retaining control by acting as the manager.  In effect, the LLC allows a producer to acquire "passive investors."  As one might expect though, there can be some major pitfalls when using other people’s money.  The LLC form has other catches as well.

To begin with, in Illinois the filing fee for your articles of organization is $500, which is over three times as expensive as filing for a traditional corporation.  The annual fee for the LLC is also over three times as expensive.

In addition, the cost of having an attorney create an operating agreement, which is the LLC equivalent of corporate bylaws, can often exceed $1,000.  An operating agreement is a complex document tailored to fit the circumstances of your project.  It should address, among other things, the following issues: the rights and duties of the manager; member contributions; the timing and amount of distributions; transfers of member interests; and dissolution of the LLC.

Another catch is compliance with state and federal securities law. Securities laws are triggered when funds are provided by one who does not actively manage the business in which they are investing.  These issues are best discussed with a securities lawyer who will often need to prepare a document called a "private placement memorandum" or "PPM."  Failing to prepare a PPM when one is required can expose you to civil and even criminal liability.

While operating in some sort of corporate form is usually the best course of action, selecting what type of corporate form that’s best suited for you and your situation may take some planning.  It may be advisable to speak with an accountant and an attorney with entertainment law experience before forming your production entity.