Protecting Your Art: Considerations for Entity Formation for Theatre Consultants

By: Brandon Shelton

I was sentanother great question from our friends in the theatre relating mainly to thebenefits and timing of forming an entity around a small voice and speechbusiness.  I like this topic a lot,because there can certainly be some benefits to forming a legal entity withyour state, but there are plenty of considerations for you to weigh todetermine if forming an entity makes sense for your line of work.  The specific question was:

“I’ma voice and speech teacher, and occasionally work as a private coach with folkson accents, vocal ease, etc.  The workcomes pretty irregularly, so as of now I just collect my fee and movealong.  I’m curious at what point I wouldwant to (or have to) consider a more formal legal structure (sole-proprietor,LLC, etc… not even sure what all the options are!) and what the pros and consare.”

As aninitial matter, it would be good to understand what your options are in termsof actual entities.  There are numerouschoices for forming entities, though since we are speaking about an individualperson engaged in providing services to clients, I will narrow this discussionto three main entity types geared towards providing consulting services: soleproprietorships, LLCs, and corporations. 

Consulting Explained

Taking astep back, when individuals provide advisory or consulting services, wherebythey assist clients in areas of their business or personal lives according totheir expertise in a particular field or line of business, it’s fairly commonto refer to the business owner as a consultant or advisor.  The difference between the two monikers isnot hugely substantive, but many resources basically say that a consultant hasa finite task or timeline by which they provide services, and advisors arebasically the same thing just with a more indefinite, ongoing timeframe.  So a consultant might be hired for a finiteperiod of two months, or through a particular Irish production for example,whereas an advisor is basically on call for all productions until the partiesend their relationship.  Given thispractice, it is relatively common to set up a formal entity through which toprovide your consulting or advising services.

SoleProprietorship

A soleproprietorship is technically not a formal entity that is created with your state.  It is more or less in existence as long asyou are engaged in providing some services for profit.  In other words, you don’t need to fileanything with the state or the federal government to be considered a soleproprietor.  If you are providing voicecoaching services at any time, the state and the federal government isbasically going to treat you as a sole proprietor.  Given that, there would likely be somerequirements for you to report any income you make so that it can beappropriately taxed at either level.

Someindividuals like to make the existence of their sole proprietorship a littlemore professional by giving the business a name and creating business cards andcontracts on behalf of the business. However, technically you are only allowed to do business under a propername of the business (which initially would just be your name).  To allow your sole proprietorship to have a nice,customer friendly name, it would be a good idea to establish a fictitiousbusiness name (or ‘dba’) with the city or county that you live in.  That’s certainly not a requirement, however,as you could simply provide your services under your name as an individualoperating as a sole proprietorship, and just make sure you reach out to yourCPA to figure out how to report the income you make through your business.

The maindrawback to a sole proprietorship, whether or not you have established a dba,is that there is no protection against personal liability for claims againstyour business.  In other words, if youare held liable to a client or a third party, the court could garnish yourpersonal wages, or require you to liquidate your Spiderman comic bookcollection to pay off any such judgements. I, for one, would not be happy about that.  For that reason, many individuals choose toform an LLC or corporation with the state in which they live to protectthemselves against personal liability.

As a sidenote, you will also likely need to file for a city business license in the citythrough which you provide your services, which is true of any business (soleproprietorship or otherwise) that is doing business for longer than aweek.  So regardless of which entity youchoose, you should at least explore establishing your city business license toensure you aren’t hit with any fines from your city.

LimitedLiability Company

The mostcommon type of entity that we see formed for consulting companies is thelimited liability company (LLC).  The LLChas a number of benefits, including protection against personal liability, anda relatively easy to maintain corporate structure.  With respect to the latter benefit,corporations require annual shareholders meetings where you elect the board ofdirectors.  LLCs typically do not have aboard of directors (unless they create one), but are rather managed by“managers” who are established immediately and hold their positions until theyleave or are replaced by a vote of the members (“members” is simply anotherword for owners of an LLC).

However,there are definitely some drawbacks to the LLC over the soleproprietorship.  In particular, LLCs mustpay annual franchise taxes.  InCalifornia, that number is usually $800 a year. Additionally, if you thought your business might grow into somethingmore than just a one person shop, such that you would like to seek outinvestors into your company, investors are more likely to invest in ac-corporation due to the flexibility of issuing equity in a corporation.  However, consulting companies rarely bring inoutside investment, as they are typically vehicles to provide personalservices, and aren’t expected to grow into some giant corporate entity.  In any case, your main consideration would bewhether or not the annual franchise tax is financially viable for yourbusiness, which would depend on the litigious nature of your clientele, and theamount of business you are bringing in. If your service is rather docile, and you only make a small amount ofannual income through your services, it might not be worth your time and moneyto create an LLC.  However, if you have alot of work coming in, and you know your clients to be rather volatile andlitigious, then it could be worth it to form the LLC to protect your personalassets from liability.

A side noteon “piercing the corporate veil”: the “Business Judgment Rule” is a rule thatessentially states that, as long as the managers, directors, and officers areusing their business judgment to make decisions and act on behalf of thecompany, a court will not second guess their decision making, unless it is sodivorced from reality that nobody in their right mind would have taken such anaction, and will protect them from personal liability.  However, if they do breach that requirement,and use the company improperly, or fail to adhere to essential corporateformalities, then a court might “pierce the corporate veil” and hold thempersonally liable for claims.

Corporations

Corporationsenjoy similar benefits to LLCs, which mainly relate to limitation againstpersonal liability for claims against the company.  Additionally, as touched on above, investorswill prefer to invest in a c-corporation due to the greater flexibility inequity.  However, the additionalcorporate formalities generally make this type of entity less attractive toindividuals providing consulting services. Given that fact, you would again have to weigh whether or not theexpense of franchise taxes and additional formalities is worth your time and money.

OneLast Wrinkle: S-Corp Elections

Newer taxrules allow both corporations and LLCs to file s-corp elections, whichessentially notifies the IRS that you wish for your entity to be treated as apassthrough entity.  As a passthroughentity, certain amounts of your company’s revenue could avoid “doubletaxation,” where the company pays certain taxes on that income, and then whenthat income flows to you, you are taxed on the personal income.  This can have significant tax benefits tocompanies if you are bringing in a certain threshold of profit into your LLC orcorporation.  To determine whether or notthis is a good idea, you should always consult with a CPA.

Back to the Specific Question

Based on the question asked in this inquiry, it would be agood idea for individuals providing voice and speech coaches to consider ifit’s worth their time and money to form an LLC or corporation, and further toconsider whether or not they should file an s-election (which again should beat the advice of a CPA).  On the onehand, it could protect such speech and voice coaches from liability if claimsare brought against them.  On the other,it can be an investment of time and money that might not be worth it.  If it does sound worth it, feel free to reachout to an attorney and CPA to further evaluate if forming an entity is rightfor you.

In terms of deciding when you should actuallyconsider forming, it would again be a judgment call.  As the business grows, and/or your personal assetsgrow, you will likely be more inclined to create some form of legal separationbetween the two.  However, there’s nohard and fast rule as to when that should be. To determine if now is the time, it would be a good idea to check inmaybe twice a year to ask yourself: (1) How many clients do I currently serve? (2)How much revenue am I bringing in? (3) How litigious are clients in this fieldgenerally? (4) How much value has been built into my personal assets? and (5)Have I heard of any horror stories from similarly situated businesses beingsubjected to lawsuits through their course of business?

Obviously, some businesses will be riskier than others.  For example, on-site construction servicesprobably carry greater risks of physical harm and claims from disgruntledclients than would voice coach consulting services (though feel free todisagree… us theatre folks can be pretty demanding sometimes).  Ultimately, it will be a bit of a judgmentcall to determine whether or not the risks outweigh the costs. 

Break a leg! (…But only yours… in fact if anyone’s legs are subject to breaking that often, maybe consider forming the LLC…)

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.