The rise of the LLC

Last March I discussed a new article by Rodney Chrisman which shows “that LLCs are by far and away the predominant choice of business structure for newly-formed entities.” I noted then the article’s findings that LLCs are increasingly choosing to be taxed as S Corporations, indicating, as I said, that “the increase in LLCs therefore isn’t just a function of their liberation from the corporate tax. It’s about better and more flexible statutes, increased learning of lawyers and business people, and improved case law.” I also observed that “[t]he numbers suggest a shift in transactional work from corporations to uncorporations” and suggested that everybody get their copies of Ribstein & Keatinge, Rise of the Uncorporation
and Unincorporated Business Entities.

Peter Mahler has also caught onto Chrisman’s article. He stresses the “dramatic disparity in the percentage of new filings among certain states.” In particular, look at the states at the bottom:

Mahler wonders why “a state as commercially important as New York [is] lagging so far behind in the LLC movement?” He gives three reasons: First, New York’s costly publication requirement for new LLCs but not corporations, which is basically a tax on business for the benefit of newspapers. Second, the problems with New York law, which I’ve documented several times (e.g.,). Third, New York has failed to update its statute.

Mahler kindly concludes:

If you’d like to learn more about the historical underpinnings and future of the LLC revolution, I highly recommend Professor Larry Ribstein’s new book, “The Rise of the Uncorporation”.

All of the large states suffer from their inability to devote the kind of care and attention to the development of LLC law that Delaware can and must do to maintain its cherished reputation as a center for business association formation. These are all signs of a race to the top in LLC law which Delaware wins because of its high-quality courts and highly responsive bar and legislature. Indeed, Bruce Kobayashi & I show in a recent paper evidence that Delaware’s courts are the key to its success in attracting larger LLCs.

Steve Bainbridge also discusses Chrisman’s article, noting that “[t]hese data reflect a considerable shift away from the corporate form and towards the LLC” and the point I stressed about LLCs electing to be taxed as S Corps, showing that it’s not all about tax.

Bainbridge concludes:

the growing number of cases in which the parties elect the LLC organizational form despite choosing to be taxed as a corporation suggests that the LLC has the potential to invade areas in which most commentators thought the corporate form would remain dominant.

Bainbridge says Chrisman’s data “raise some interesting questions”:

1. Should corporation statutes concede the nonpublic field to LLCs and focus solely on the problems of public corporations, while providing basic rules for legacy nonpublic corporations?
2. Should drafters of the Delaware and the Model Act seek to rewrite their statutes so as to provide a corporate form that can more effectively compete with the LLC to be the form of choice for all nonpublic entities? Or, in the alternative, to provide a corporate form that can more effectively compete with the LLC to be the form of choice for certain identifiable categories of nonpublic entities for which the corporate form is especially suited?

My answers are yes and no respectively. The close corporation was a transitional form whose time has passed. Uncorporations have distinct attributes that are suited to closely held firms and that should be presented in distinct statutory forms, as argued at length in my Rise of the Uncorporation, linked above. Corporate statutes should focus on the corporate domain of publicly held operating firms.

Although the corporation is not dead – it is still useful for larger businesses – it is no longer unquestionably dominant, even for large firms as also argued in my book. It’s time for all lawyers to finally learn about the alternatives to incorporation, for which I’ve suggested some reading above. Get to work.