Contractors as LLCs: Are There Advantages?

By Ben Price, VP, Regents Bank: A Q&A with a San Diego attorney reveals the pros of a contractor using an L.L.C. form of ownership.

I recently sat down with San Diego attorney Whitney Skala to shed light on amended legislation allowing contractors to use the L.L.C. form of ownership. Mr. Skala is an expert on entity formation and frequently writes and speaks about the topic.

Ben Price:  I understand recently amended legislation allows contractors to use the L.L.C. form of company ownership. Why would a contractor want to form an L.L.C.?

Whitney Skala:  The legislation allowing for Limited Liability Companies (LLCs) was enacted in California in the mid-1990’s, but only recently was the legislation amended to allow contractors to use the L.L.C. form.

LLCs have been an option available to other businesses for years, and those businesses opt to use the L.L.C. because of its flexibility, both as to management and to capital structure.  Those advantages would hold true for contractors as well. Internally, the L.L.C. can adopt voting and consent rights in order to empower or protect investors on all sorts of different business issues, and founding members who contribute capital can insist on the return of their capital from the LLC’s proceeds before other profits are distributed.  Also, LLCs don’t need annual meetings or a board of directors—with a corporation, if you have three or more shareholders, you need three directors.

BP:  Those sound like powerful advantages.  I could see an L.L.C. being very helpful where a contractor needs substantial capital to purchase equipment but can’t otherwise get credit or loans for the purchase.  The investor, I am guessing, remains as a member of the L.L.C. even after the capital is repaid?

WS:  Yes, but the parties could agree to a buy-out in favor of the L.L.C., at a formula that would require the L.L.C. to pay off the invested capital and provide an additional return to the investor.  That buy-out would allow the contractor to resume sole ownership.

BP:  Plus, as a banker, it would be easier for me to offer a credit line to an L.L.C. that had used its own capital to acquire its equipment.  Are there any downsides to a contractor being an L.L.C.?

WS:  The contractor must still meet the responsible managing employee/officer (RMO/RME) licensing requirements with the state.  Also, the Franchise Tax Board (FTB) will tax the L.L.C. based on gross revenues, not profits. This tax could greatly exceed the $800 annual FTB fee that a corporation is charged.

Regents bank VP Ben Price offers expertise in areas ranging from commercial lending and real estate appraisal to management and marketing. He can be reached at bprice@regentsbank.com. Mr. Skala can be reached at whitney@skala-apc.com.