BUSINESS ENTITY FORMATION
If you think you need an “entity” for your new or existing business, you have undoubtedly seen lots of “We’ll form any company for $99! Act now and you’ll also get this beautiful Zirconium ring at no extra charge! But wait, there’s more—act now, and get 2 companies for the price of one!” ads out there.
Sorry, that’s not us. The choice of entity for any business, partnership, real estate investment group, non-profit or charitable organization is way too important to be left to fill-in-the-blank online setup outfits.
Choosing The Right Entity Is Important
Ask yourself: WHY do you want “an entity”? What TYPE of entity is best for what you intend to do? What provisions in your operating agreement/shareholder agreement/partnership agreement do you NEED? Better yet, which ones do you NOT need? What are the implications of using one form over another? WHERE should you form your company? (hint: the answer is almost never “Nevada”). Need a fictitious name? Or maybe you do not need an entity at all— perhaps just a heaping bunch of insurance is appropriate for YOUR situation.
And think about this: Will your business partner and best buddy Jimmy’s soon-to-be-ex-wife end up being your “partner” after a divorce or if something happens to Jimmy? Let’s face it: Jimmy’s a great guy, his ex-wife……not so much. We don’t blame you.
Seriously, forming an entity is important. Really important. There are lots of little details that wouldn’t (and, truthfully, shouldn’t) occur to most people. “Winging it” here is just asking for trouble down the line. If you go the do-it-yourself route, when do you know things are not right? When it’s too late. We know – we get the calls after things start falling apart.
What We Do
Whether you have an existing business, are just starting out, or are forming a joint venture for the tenth time, it is important to make sure all the bases are covered—or at least as many as you can when looking into that crystal ball that is the future. We take the time to talk with you so the important questions are answered; ninety-nine times out of one hundred, when we talk to clients about structuring new entities, we trip across 2, 3, or 10 other topics that are impacted by the new company’s formation, all of which have to be addressed.
Some choices to consider for entities are sketched out below. Read them for background information, then call or email us—we are always happy to talk to new or existing clients about their business plans and what might work best for them.
Limited Liability Company
A limited liability company is kind of a cross between a corporation and a partnership. It provides easy management and “pass-through” taxation (profits and losses are added to the owner(s) personal tax returns) like a sole proprietorship or partnership–with the liability protection of a corporation. It is a separate legal entity (think “separate person”). However, there is no stock and there are many fewer formalities. The owners are “Members,” not “Shareholders.”
The heart and soul (and critical element) of a LLC is the “Operating Agreement”. This is how you keep Jimmy’s ex-wife from becoming a co-owner of the business with you. It sets the rules for operating the company and can be modified as the business grows and changes. This document requires some thought and careful planning.
The Skinny: The LLC is the entity of choice for 1-5 person companies (although even companies as large as Chrysler® are LLCs) and has surpassed the corporation in popularity. Ease of management, transfer, modification and limited formality/compliance requirements make LLCs a user-friendly entity solution.
“Doing Business As” or “DBA”
A DBA (also known as a “sole proprietorship”, “Doing Business As”, or a “Fictitious Name”) is a business that is not separate from its owner(s)—it’s just a different name that the business owner operates under. The owner(s) is personally liable for the company and its debt. If there is more than 1 owner, then the business is a “General Partnership”—kind of the worst of both worlds: each owner is responsible for all the acts of all the owners—unlimited liability!
The Skinny: Stay away. No protection, lots of potential liability.
Corporation (or C-Corporation)
A separate legal entity that can shield owners (shareholders) from personal liability and the debts of the company. A good thing, no? It can buy real estate, enter contracts, and sue and be sued – all completely separately from the owners. Ownership can be transferred through the transfer of stock. The duration of the company is perpetual–it can continue regardless of ownership. There can also be tax advantages.
Basically, a corporation is set up as:
Shareholders own the stock of the corporation.
Shareholders elect Directors (the “Board of Directors”).
Directors appoint Officers (President, Secretary, Treasurer, etc.).
Officers run the company (day-to-day operations).
In many cases–especially with startups–one person is Chief, Cook & Bottle Washer. That is, one person is often the 100% owner of the stock, who elects the directors (usually the same person) and then appoints the same person as all the officers: CEO, Treasurer, Secretary. It’s a lot of hats to wear.
The operating rules are set in the “Bylaws”. That sets the rules for the company and can be modified as the business grows and changes. Operating a corporation involves, at the minimum, holding a yearly Directors and Shareholders meeting, keeping written minutes of major company decisions and maintaining strict corporate formalities and corporate compliance as dictated by the Bylaws and laws of the state it is formed in (and operating in).
The Skinny: More complicated to run and manage than the LLC, the corporation is still the oldest (and maybe most “prestigious”?) form of entity. Formation of corporations is becoming increasing rare given the ease and flexibility of using LLCs or other forms. Electing to be an “S Corporation” (see below) makes things a little better.
More a tax decision than truly different “corporation.” A corporation may elect “S-Corporation” status by adopting an appropriate resolution and completing and submitting a form to the Internal Revenue Service (and, possibly, the state). Once complete, the corporation is taxed like a partnership or sole proprietorship rather than a corporation. There are limitations on S-corporations: for example, they may not be able to deduct some expenses like health insurance, travel, entertainment, etc.
The Skinny: Though taxed like LLC’s, S-corporations still require all the corporate formalities of a regular corporation (holding Board meetings, keeping minutes and resolutions). Like regular corporations, they may be on the path of the dodo for all but unique situations.