The title of Professor Rodney Chrisman’s study of business formations in the U.S., published last year, proclaimed limited liability companies or LLCs the “New King of the Hill.” Chrisman’s study, which I wrote about here, gathered nationwide business formation data showing that, as of 2007, the rate of new LLC formation was approximately double that of traditional business corporations. Chrisman’s study also revealed a huge disparity in the state-by-state rates, ranging from Connecticut on the high end with LLCs constituting 92% of new business formations and Illinois on the low end with only 38%. New York came in second to last at 40%.
In my report on the Chrisman study I suggested several reasons for New York’s poor showing, starting with New York’s unique status as the only state requiring expensive newspaper publication notice for all new LLC formations (but not for corporations). I then suggested two secondary explanations: the relatively undeveloped body of case law implementing New York’s LLC statute, possibly causing lawyers to steer clients into the better-charted corporation waters; and the dearth of legislative improvements to NY’s LLC Law since its adoption in 1994.
I’ll have to settle for one out of three. It turns out that, on average in New York, it costs $625 more to form a new LLC versus a corporation, of which $500 goes into the pocket of newspaper publishers — and that reason alone overwhelmingly is responsible for New York’s poor showing. The cost differential is much higher in downstate New York where publication charges often exceed $1,000.
You ask, who says? A new study by Daniel M. Häusermann of the Swiss-based Research Center for Information Law, entitled “For a Few Dollars Less: Explaining State to State Variation in Limited Liability Company Popularity” (read it here), presents a sophisticated statistical analysis demonstrating that, in his words, “formation fees, rather than taxes or substantive rules or anything else, explain the variation in LLC popularity best,” alone responsible for “17% to 28% of the state-to-state variation in LLC popularity.” The explanatory power of differentials in formation fees, the study finds, “is greater than the explanatory power of all other variables taken together.”
Using 2009 data, the above table from the Häusermann study ranks LLC popularity in the 50 states and District of Columbia measured in three different ways. At the top is Connecticut with a rate of LLC formation 12.3 times the number of corporations. At the bottom is Illinois, with a ratio of 0.70 LLCs formed for each corporation. New York’s LLC formation rate barely edges Illinois’.
The below table also from the Häusermann study ranks the states by highest-to-lowest differential in entity formation fees between LLCs and corporations. New York’s $625 differential places it about 80% higher than second place Illinois. For the overwhelming majority of jurisdictions, the differential is either tiny, or non-existent, or actually favors LLCs.
Häusermann states that he conservatively estimated New York mandatory publication costs of $500, and in a footnote on page 17 of his study he adds that actual publication costs range from $200 to $2,500 depending on the place and the newspaper. He cites another source indicating publication costs from $700 to $1,000 in New York City and from $295 to $1,250 elsewhere in the state. He also notes the $750 cost for LLC formation in New York used in his above table includes a $50 charge imposed by the state for filing the certificate of publication.
Häusermann’s statistical analysis looks at a number of other possible factors but, in the end, finds little or no correlation between them and choice of entity. These other factors include state LLC law default rules for dissolution, agency powers, veil piercing, member disclosure, fiduciary duty waiver, and prevalence of mandatory rules. “The only evidence that substantive law matters,” he finds, “comes from a variable that indicates whether a state’s LLC statute allows LLC members to withdraw from the company” — New York’s does not. He also (surprisingly) finds no correlation between choice of entity and post-formation periodic cost differentials such as biennial report fees, franchise taxes and other state entity-level taxes. On the other hand, he does find that about 10% of the variation in LLC popularity is explained by whether the state’s LLC statute, as in Delaware and a number of other states but not New York, expressly provides that “maximum effect” shall be given to the principle of “freedom of contract.”
When it comes to choice of entity, Häusermann sums up, “reminiscent of the Wild West . . . [m]oney is important, legal rules are of dubious significance, and freedom is appreciated.” In short, “people tend to choose the entity that they can get ‘for a few dollars less'” (with appropriate hat tip in footnote 163 to Sergio Leone and Clint Eastwood).
I reached out to New York City lawyer Imke Ratschko, whose firm specializes in assisting owners of small businesses and who publishes the popular blog, New York Small Business Law. Imke commented that most of her New York City clients opt for the formation of an LLC, despite the initial shock over the steep publication costs. She usually succeeds in convincing them that the LLC is the more flexible, less paper intensive and better choice for closely held startup businesses, despite the higher price.
Imke’s comments suggest that Häusermann correctly identifies areas for future empirical research including the impact of local legal culture and the business entity choices and formations at the individual level. For example, I would expect to see a higher rate of LLC selection among entrepreneurs who use business lawyers to assist the start-up than those who forgo legal assistance in favor of using online services or accounting professionals.
Leading academics such as Professor Larry Ribstein (read here his piece on the Häusermann study) have been preaching for years about the significant advantages of the LLC form for closely held businesses. It is hard to believe that New York, as the leading commercial state, lags so far behind the rest of the country in LLC formations. The Häusermann study adds a strong, statistical punch to the argument for repealing New York’s unique, obsolescent requirement for newspaper publication of LLC formation. Assuming publication ever served a useful purpose, it clearly no longer does when all of the published information simultaneously is freely available on the website of the New York Department of State. The real problem is the strength of the newspaper publishing lobby in Albany which stands to lose significant advertising revenues if the law is repealed. Perhaps someday our legislators will realize that the favor they’re showing publishers is hurting the business community and chipping away at New York’s competitive edge.