Organizing Your Band as a Company: A Way to Protect Yourself and Keep Friends

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Do you know that if you start a band and don't formally organize it as a company that you've chosen the worst business format? Do you know also that if the band faces a legal problem, you could lose your equipment, your car, your house as well as your money even if you had not caused the problem?

The answer to all of these questions is that it can happen. So, can you protect yourself?             

The answer is yes. But whatever you do whether it's formalizing a company or signing a contract pieces of paper won't stop misbehavior.

Many of my clients ask the same question: "Can someone sue me for this?" I answer: "Anyone can sue anyone for anything." But my clients ask the wrong question. They should ask: "Who will win?" The answer is that it depends. For problems between band members, it depends on what steps you take or don't when you first start a band. So, here are some straight answers that can help you prevent disasters while trying to make music and money.

According to most state laws, two or more people who do business as a team and take no formal steps to organize their business work in an equal partnership. If you play a gig under your band's name or open a bank account for the band, then you have started an equal partnership.

I really really dislike partnerships. I'll tell you why.

Let's say you start your band and don't formally organize or register it as a business. You start performing publicly and become popular. One of your fellow band members, Bad Boy, commits the band to a gig, signs a contract with its promoter, and doesn't tell anyone else about it. He then splits to Bolivia with a $50,000 deposit the promoter gave him. And, except for you having received a $50,000 inheritance recently, the other band members are broke. The date for the gig passes, and the promoter is mad that your band didn't show. Guess what? You're going to lose your inheritance. According to most state partnership laws, each partner is equally liable for any debts of a partnership or those any partner incurs within the scope of its business. Bad Boy's act comes within the scope of the band's business. Each partner, therefore, is jointly and individually liable for the entire debt.

By law in most states, however, you have a right to receive a pro-rated repayment or contribution from the other partners. But Bad Boy is off sipping pina coladas in Bolivia, the other band members are broke, and you have the money. You get to pay the whole thing. Nice, huh?

Aside from personal liability problems, there are several other reasons why equal partnerships are inappropriate for a band. Remember that without a written partnership agreement, the law assumes that the business owners all are equal partners. This may not be true for your band. Your drummer may have another steady gig and isn't committed. Should she get an equal cut? One or two members may write all of the music. Who owns the publishing rights? Another member may have thought of the band's name. Do the other members own part of it just because they're in the band? Partnership law assumes each business owner receives an equal share of the performance, music publishing, and songwriting income. Maybe that's the way you want it but maybe it isn't.

You can address these issues with an internal written agreement that directs the band to make decisions together and write them down. Or, the band may agree that it will not split the gig money equally and that one person owns the name. You can't, however, contract around the partnership liability provisions. In other words, your internal contract is irrelevant to an outside creditor who still can seek your personal assets to pay band debts.
 

Fortunately, you can take a few easy steps to handle most partnership -related problems, especially liability issues. No matter what you do, you still can be sued, but there are ways to protect your personal assets.

I usually suggest two types of business formats for my clients. When used properly, they protect each member's personal property from the reach of creditors. The first one is a corporation, and the second form is a limited liability company (LLC). Both of them offer limited liability, which makes the company liable for business debts instead of its owners. If your band is sued and loses, it may have no assets and declare bankruptcy. Afterwards, you could get in the Lamborghini you bought in your name with the dividends the company paid you and drive to your vacation palace. You still, however, can be held liable for committing fraud or failing to pay taxes.

Why would anyone do business as a partnership, when they could set up a corporation or an LLC and not worry about personal liability? Well, the first reason is the start-up cost. In a partnership, you have no costs related to making the business formal. Other forms of business have one-time legal, accounting, and filing costs as well as annual fees. Another reason is that corporate income is subject to double taxation. A corporation is a taxpayer, and it pays taxes on its income. People paying you for gigs would give the money to My Band, Inc. When you write yourself a paycheck from My Band, Inc., the money becomes your personal income that also is subject to taxes.

An alternative is the Subchapter S corporation. The "S" stands for small. The government allows small businesses to elect "S" status, which eliminates any corporate level tax. Thus, you would pay taxes on income only once. The "S" corporation also has the limited liability of a regular "C" corporation.

The "S" corporation until recently had been the most common business format for bands. But there are limits on how an "S" corporation may operate. The government has limited their number of shareholders, amount of assets, and fiscal year end dates. Also, an "S" corporation only can have one class of stock, which means it can't have voting and non-voting shares like a regular corporation. Some of these limits can restrict the way band members want to operate their business.

Another form of business is the LLC, which most states now allow. It's similar to an "S" corporation because it limits individual liability and pays taxes as a partnership. But it has some advantages over "S" corporations. Owners have much freedom to organize and run it almost any way they want. They can have different classes of voting stock, and owners must follow fewer formalities compared to an "S" corporation.

I tell my clients that they should ask their accountant whether he has a preference for "S" corporations or LLCs. For protecting an owner from personal liability, either form will work. Some states have complex rules for forming LLCs. New York, for example, requires owners to announce new LLCs in a newspaper advertisement. Filing fees also vary between states, but the final costs for forming an LLC generally are the same. Tax and other non-liability issues, though, could affect a band's choice of location. Each state has different rules about pension plans or the ability to go public. That's why you should involve an accountant as well as a lawyer when organizing a business. Some accountants and lawyers are familiar with "S" corporations and prefer them. But because LLCs are new since the mid-1990s, not much case law about them exist. Many professionals would rather deal with the corporation format that they have more experience working with.

Whatever you choose, you should have a written shareholder or operating agreement between the band's members. The agreement should include all of the issues you believe could affect the business of the band. Think about this scenario: Two people own a band and one person can't stand the other's wife. If the second person dies, does his wife inherit his shares of the band? Or if he dies, must his estate offer to sell the first person the shares before the wife?  Even more questions: Who receives the band's publishing revenue? Who controls the merchandising and tie-in deals? Although no right way exists to handle these issues, there is one wrong answer: "Don't worry about it. Why should we spend money on lawyers, filing fees, and accountants when we all know the deal between us?"

If the story about Bad Boy doesn't scare you, then try this: Oral agreements in most states that can't be completed within one year are not enforceable. Therefore, an oral agreement between band members who have been together for more than a year is no good. Nevertheless, an oral agreement, even if it's enforceable, does not include anything written on paper. In my experience of practicing entertainment law, I have met many people who often forget or have a selective memory of events.

Although lawyers, accountants, and filing fees cost money, the expense of setting up your operations properly is small compared to the cost of a lawsuit.
My favorite analogy for this situation is a television commercial that aired in New York City a few years ago for a brand of automotive oil. In it, a mechanic held a can of oil and said, "change your oil every 3000 miles." A tow truck behind him pulled a car into his garage. The mechanic smiled and said, "you can pay me now, or you can pay me later. It's up to you."

Well, it's like that with lawyers. It's easy and inexpensive to organize an "S" corporation or an LLC. But, more importantly, either format will help your band resolve legal issues before they arise, which allows you to get to the real business of making and performing music.

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