How To Select the Perfect Entity for Your Craft Brewery, Winery or Distillery
Operating as a sole proprietorship, generally, and even more so in the alcoholic beverage industry, is a dangerous proposition that should be avoided at all costs. If you are not operating your business through a limited liability entity, your personal assets (i.e. home, car, bank accounts) could be and likely are exposed to liabilities incurred by the business. Potential liabilities are everywhere in this industry, from the products you produce and sell, to the debts and obligations you take on, to the employment and payroll decisions you have to make. Additional liabilities may be incurred if you invite people to your business site for tours and tastings. Thus, operating your business through a limited liability entity is highly recommended.
Selecting the best limited liability entity for your craft brewery, winery or distillery is no easy task nor is it a trivial decision to be taken lightly. Without thorough research and extensive thought, an educated decision as to what entity is right for your business cannot be made. And although it is often possible to change the type of operating entity mid-way through your businesses’ life-cycle, if necessary, it is not usually easy or painless and often involves negative tax implications, payroll and other operating disruptions.
This is why it is important to select the right entity the first time and ideally before you begin doing business. This is especially true in the alcoholic beverage industry, where it is greatly preferred to have the entity in place before acquiring the many required licenses and permits to avoid a possible duplication of licensing and permitting efforts later on. Although there is not one magic choice for alcoholic beverage businesses, there are certain factors that you should consider when deciding which entity type is right for you and your business.
When I advise “start-ups” and emerging businesses regarding entity selection, I recommend that they focus, initially, on three criteria:
- Liability Protection
- Ease of Governance/Maintenance
Of course, there are other considerations, some of which are particularly important for alcoholic beverage businesses, such as which entity or entities are “fundraiser friendly”. These additional factors, though, I set aside for later when the client has already boiled the possible entity types down to a couple based on the above factors.
Below, I have listed the most often-selected types of limited liability entities, along with some of the more important features of each. However, one should not underestimate the importance of finding a knowledgeable attorney and accountant with whom to consult before making such a vital decision, as everyone’s situations are unique.
- Liability Protection: C Corporations offer limited liability protection, which is important to shield your personal assets from liabilities incurred by your business.
- Taxation: The major disadvantage for C Corporations is that they are “double taxed”. This means that for each dollar of revenue earned by the business, it is taxed once at the corporate level, at the corporation’s tax rate, and then again when that dollar is distributed to the corporation’s shareholders, at the individual shareholder’s tax rate. Ouch!
- Ease of Governance: Another drawback of using a C Corporation is that there are many strict maintenance requirements. Most often a formal corporate board and officers must be put in place, annual meetings must be held and meeting minutes must be recorded and maintained. For smaller businesses, these rigorous requirements are often found to be overly burdensome.
- Other: C Corporations are still viewed by many venture capitalists and angel investors as the most trusted type of entity, due to the fact that they have been used for a long time. For purposes of fundraising, this may be the best option for you.
- Liability Protection: S Corporations offer the same limited liability protection offered by C Corporations.
- Taxation: S Corporations are “pass through” entities, which means that revenues are not taxed at both the corporate and shareholder level, but instead “pass through” straight to the shareholders and are only taxed at the shareholder level. This can be a meaningful advantage.
- Ease of Governance: S Corporations are standard corporations that elect a special tax status with the IRS. Accordingly, the governance and maintenance requirements are similar to those of a C Corporation, which can prove to be burdensome.
- Other: S Corporations can also be beneficial if you want the flexibility to set salaries for employees/owners to minimize FICA and FUTA taxes. There are some drawbacks, though, such as the inability to have multiple classes of shareholders and a limitation on the total number of shareholders that can be in the S corporation.
Limited Liability Company:
- Liability Protection: Limited liability companies offer the same limited liability protection offered by C Corporations and S Corporations.
- Taxation: LLCs offer the flexibility to be taxed in a variety of ways. By default, a single member LLC is taxed as a disregarded entity (like a sole proprietorship) and a multi-member LLC is taxed as a partnership. However, LLCs can also “check the box” and elect to be taxed as a C Corporation or an S Corporation, if that is more beneficial for the business.
- Ease of Governance: LLCs offer great flexibility with respect to governance as well. Although it is highly recommended that a multi-member LLC have an operating agreement in place (an operating agreement is much like a partnership agreement), there is often no requirement that LLCs hold annual meetings, maintain a formal board and/or officer structure or maintain regular meeting minutes. That said, LLCs can be set up with formal boards and use an officer structure, if the members so choose; and, thus, LLCs can look just like a corporation if that is preferred. It is the flexibility and ease of governance that makes LLCs so attractive.
- Other: LLCs are relatively new entities and, for that reason, are not often seen in the same light as the more traditional C Corporation by many venture capitalists, although this thinking is waning. The flexibility of the LLC often makes it the preferred choice of many start-ups and emerging businesses.
While this article outlines many of the advantages and disadvantages of the most often-selected limited liability entity types, it cannot be emphasized enough that everyone’s situation is unique and there are many factors, in addition to those listed above, to be considered. It is always recommended that a business that is just starting-up or emerging should work closely with a knowledgeable attorney and accountant so that the decisions made at the beginning of a business’ existence, which are often the most impactful decisions to be made, are made correctly. Making the correct decisions early will establish a strong foundation for success later!
This blog was written by Hank Abromson at Miles & Stockbridge.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.