By Derek Larsen-Chaney and Jason Pill, Attorneys with Phelps Dunbar, LLP
Part 1 of CBJ’s series on corporate expansion looked broadly at the reasons for internal or external expansion of a climbing gym, and Part 2 discussed the options for external expansion, including mergers and acquisitions. In Part 3, the final part of the series, attorneys Derek Larsen-Chaney and Jason Pill explore the liability implications when expanding a gym across state lines, and they conclude the series with final takeaways on the question of expansion.
Expanding a Corporation
States encourage most new businesses to begin operations in their state, so the process to relocate or expand is typically not onerous. Corporations expanding into another state have multiple options available to them. If you wish to expand your operations into an additional state while continuing to operate in your home state, you must register as a foreign corporation doing business in the new state. This typically requires submitting a brief application with the new state’s division of corporations. The new state will want to confirm that your company is in good standing in its home state before allowing it to operate within the new state’s borders. If you wish to move the corporation and its operations from one state to another, you will need to complete a process called domestication, which requires a handful of forms to be submitted in both states. Or, you may form a corporation in the new state and have the old corporation merge into it, a process referred to as reorganization. You are responsible for paying duplicative annual report and/or franchise taxes if you maintain the old corporation and register to do business in a new state. However, reorganization for a C corporation can be entirely tax-free since there is no tax on the merger, but only if you choose to have the merged corporation not recognized in its original state. In this case, there may still be liquidation issues which result in income taxes being imposed on the corporation and its shareholders.
Key Considerations: The most important issue to be aware of when expanding a corporation across states is that operating in multiple states may expose you to being sued in multiple jurisdictions. An entity can be sued in its home state, regardless of where a cause of action occurs, so you may be forced to defend a lawsuit far from your new location. This risk would be diminished if you can stop liabilities from flowing from one location to another by operating each location as its own dedicated entity. You will also need to make yourself familiar with the corporation laws of each state in which you do business. Annual filing and tax fees vary wildly from state to state.
Expanding an LLC
Like corporations, LLCs have the option to continue in the old state and register as a foreign LLC in the new state. Similarly, this would result in duplicate reporting and tax fees. By contrast, there are no federal tax consequences for liquidating an LLC. LLCs are known as pass-through entities and, therefore, are not required to report any gain from liquidation. Unlike expanding a corporation through a merger, forming an LLC in the new state and merging the existing LLC into it—or domesticating the existing LLC in a new state—is viewed as a continuation of the old LLC. Provided the LLC members from the old state continue to own at least a 50% interest in the capital and profits of the LLC in the new state, there will be no immediate tax consequences.
Key Considerations: As with corporations, it is typically considered “best practice” to hold locations in separate entities—one LLC for Tampa operations and another for Denver operations, for example. Doing so minimizes the risk of liabilities stemming from operations at one location—an injury to a customer or employee, or other—from attaching to another location. In all instances, for both LLCs and corporations, in order to enjoy the personal liability protection and the protection of one entity from another, it is imperative to follow all requisite formalities, including avoidance of comingling of funds, so that there is a clear line between owners and entities. Creating and maintaining separate LLCs can be a cumbersome organizational endeavor, and each entity will require its own corporate records, operational documents and bank accounts. But this separation can also be beneficial for payroll, tax, and regulatory purposes, since those matters may be distinct from state to state.
Making a Decision
Some owners of small businesses choose not to expand—sometimes because they started their small business with the intention of remaining small so they could maintain their close connections with customers and employees and be free from the burdens of wide administrative management. Remaining small has some perks, such as keeping loyal customers, maintaining control, and reducing expenses spent on additional employees and facilities. Not to mention, choosing not to expand provides business owners schedule flexibility to devote time to family and other interests (like climbing) that may otherwise be allocated to expansion efforts. However, even without the desire to expand, the inability to manage rapid business growth may lead to dissatisfied customers, mismanagement of profits, a damaged reputation and, possibly, a need to close the business. For example, if a gym experiences unplanned growth, it is almost inevitable that it will also experience periods of crowdedness and receive customer complaints, which may include a demand for a new facility. Staying the course is not always possible.
Business owners often take a great deal of time before making the decision to expand, but too often owners reflect on their own independent and private desires when making the decision. Ultimately, the decision should be based on the betterment of the business, not personal aspirations. Sometimes business growth demands expansion, while other times businesses need to remain small in order to succeed. We conclude this series on corporate expansion by providing broad takeaways to consider when deciding whether to expand your climbing gym.
The biggest benefit of expanding is brand exposure. More locations can result in an increase in revenue and, at a certain point, a reduction in overhead costs. This leads to another benefit: the financial ability to introduce new products and services to your customers (you can finally try that organic juice bar you’ve been thinking about for years). New locations can also enable you to target new communities, and expansion can lead to greater efficiency and economies of scale which allow you to undercut your competitors in those communities. Expansion can also put you a step ahead of the competition when customers who typically would not have used your services because of distance now make use of your brand-new gym nearby. Similarly, if you expand through mergers with a former competitor, you can diminish your competition outright.
One of the most critical challenges with expansion is money. Expansion can be expensive no matter which expansion strategy you use. In addition, expansion calls for a new demand on management that includes more pressure to perform proactively. If service quality drops, you may lose customers to competitors, and staff turnover may increase due to the heavy workloads. Expansion can also lead to a weakened business culture for owners when they must allocate their time to multiple locations, which may strain their relationships in the original local community.
The decision to expand is a critical decision facing every successful climbing gym owner, and every choice comes with perils. Expansion, therefore, must always be deliberate and methodical.
Note: The content of this article is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. The reading of or reliance on this article or the Climbing Business Journal’s web site does not create an attorney-client relationship between the author or the Climbing Business Journal and the user or reader.
Derek Larsen-Chaney is an attorney with Phelps Dunbar, LLP in Tampa, Florida. Derek practices in the areas of business and finance with a focus on real estate transactions, commercial lending, and corporate formation, including start-up business and climbing gyms. Derek has also provided guidance to startup companies in secured financing, private placement fundraising, and SEC reporting obligations.
Jason Pill is a longtime climber and an attorney with Phelps Dunbar, LLP in Tampa, Florida. He practices in the area of Employment Law by advising clients, including climbing gyms, on workplace issues and representing clients in state and federal court when litigation becomes unavoidable. Additionally, Jason managed a climbing gym before embarking on a legal career, and he currently serves on USA Climbing’s Board of Directors and as the Chairperson of USA Climbing’s Ethics Committee.