February 4, 2013 |

2010 July: Pizza Inc.

By Daniel P. Smith

The legalese and tax speak made Kelvin Slater’s head spin. In 2003, as Slater readied to open Blue Moon Pizza in Marietta, Georgia, he struggled to discern the best legal entity for his restaurant. Even as he poured over research and heeded professional advice, questions swirled.

“My wife and I studied the heck out of the different (legal entities) and did our best to understand everything could,” Slater says, noting that he eventually settled Corporation based on ease and price.

For many proprietors, deciding on the proper can prove a daunting, confusing task. Yet, understanding the details and making an informed decision can break a pizzeria and its owners. Establishing a legal affords the operator legal distance and personal from business miscues, namely unnecessary legal exposure.

“Incorporating or setting up a limited liability (LLC) for a business can protect a business owner’s personal assets, since an owner’s liability is generally limited to his or her investment in the business,” says Elke Hoffman, a New York-based attorney specializes in hospitality entrepreneurship.

Most pizzeria owners select one of three pathways, each with its respective benefits and drawbacks: 

Sole proprietorship. A sole proprietorship, viewed as a business of one and a frequent starting point for many, is the most basic form of business ownership with no significant costs outside of securing the necessary licenses and permits. “What is critical to understand is that the individual represents the company fully and legally,” says Atlanta-based attorney Charles Hoff, the Georgia Restaurant Association’s general counsel.

While a sole proprietor may operate under a trade name, there is no separate legal entity or formal business structure, leaving the owner personally liable for all debts and actions of the business. Although the sole proprietor gains freedom from some business bureaucracy, the lax structure can be detrimental to the business, proving it difficult to expand or attract investors.

Corporation. A corporation is a distinct legal entity with ownership divided into shares and overall management conducted by a board of directors, which can be the individual owner alone. A corporation is started by filing articles of incorporation with the state, a $250 to $450 process simplified by helpful accountants, attorneys, and Web sites.

Most incorporated restaurants pursue the S Corporation label. Issuing only one class of company stock, S Corporations offer limited personal liability, pass through tax treatment, FICA and Medicare tax savings, and a reduced number of social security recipients. However, S Corps are also hampered by a number of technical rules regarding shareholder limits, distribution, and tax benefits that can generate extra paperwork.

“The biggest advantage to a corporation…is that if the corporation is properly formed and capitalized and the corporate formalities are maintained, the liability of the shareholders is limited to their investment in the corporation,” Hoffman says, adding that about half of her clients pursue S-Corp status. 

Limited liability company. The LLC offers the liability cushion of a corporation and the tax advantages of a partnership. Governed by its operating agreement, an LLC can be formed in much the same way as a corporation and for approximately the same filing fees.

Flexibility leads many pizzeria operators to follow the LLC route, which can be set up to resemble a corporation (issuing shares with a board of directors and officers) or a partnership with collective restaurant management. Easy to operate, LLCs provide simplified profit distribution and do not require corporate formalities. Most importantly, members cannot be held personally liable for debts unless they have signed a personal guarantee.

“What most owners find appealing is the ‘fl ow through taxation’ component in which all business losses, profits, and expenses fl ow through the company to the individual members,” Hoff explains. “In this manner, an owner is able to avoid double taxation of paying both corporate tax and individual tax.”

But LLCs have their limits. While a corporation may live indefinitely, an LLC is dissolved should a member undergo bankruptcy or die. Additionally, there is a greater complexity involved in running an LLC, including federal classifications that need to be investigated for tax purposes. 

Closing arguments. Given the personal liability risk of sole proprietorship, the vast majority of operators commonly opt for the S Corp or LLC legal designation.

“I would advise any retail establishment that is open to the public, and especially a food service establishment, to incorporate or form a limited liability entity… (which) gives some additional protection at a very low cost compared to obtaining additional insurance,” Hoffman says, adding that multi-location operators might even set up legal entities for each location, a move that can protect the overall business should claims occur at one specific location.

In all cases, Hoffman and Hoff advise operators to consult a tax professional for more in-depth understanding of their personal situation, including plans for growth, franchising or selling the business.

“Factors such as the number of owners and employees, whether any investors have been promised distribution preferences, if employees are to be given equity, the exit strategy, whether the owner needs to offset other business gains or losses, whether the owner will be an employee and the initial costs of forming each in any particular jurisdiction will affect the choice of entity,” Hoffman says.?

Ready resources: Advice available online and locally

Seeking credible information on the legal entity right for your pizzeria?

Online resources include LegalZoom (www.legalzoom.com) and V Corp. (www. vcorpservices.com), both of which offer online fi ling and include form bylaws or single-member operating agreements in their corporate kits. Nolo (www.nolo.com) has information and publishes materials with legal forms online as well.

In addition, state restaurant associations and many localities also have offices to assist small businesses, while local colleges frequently offer entrepreneurship courses that cover setting up a legal entity.

While saving cash is tempting, Hoff urges a degree of caution. Consulting with an attorney or accountant, many of whom offer free initial consultations, can provide operators a better understanding of the legal, accounting and regulatory checklist they need to consider for their establishment. Thereafter, Hoffman says, “The operator can better determine what items he or she can comfortably do independently.”

Chicago-based writer Daniel P. Smith has covered business issues and best practices for a variety of trade publications, newspapers, and magazines.