The steps one must take to become a successful entrepreneur can be both exhausting and exhilarating. Do I have a solid business plan? What should I name my company? What about office space? A company logo?
Of all the decisions that await, one in particular will impact taxation, personal liability, record keeping, and your ability to raise money. Choosing the right business structure will have a lasting impact on your business. That’s why an acknowledged best practice is to surround yourself at formation with talented, capable professionals who excel in such areas as law, taxes and accounting.
It’s important to note that you will be forming your chosen entity type within a particular state (and maybe qualifying it to do business in one or more other states) so consulting with legal counsel familiar with the laws of the state in which your primary place of business will be should be part of the process to ensure your new firm’s compliance.
The Value Experts Provide
Selecting the right entity type will have a lasting impact on your business. By working with legal counsel, you will be better informed and can make decisions based on your long-term vision for your new firm.
There is no simple answer to “what entity should I form” ; however, the key considerations that should be used to determine include:
Management: Do you want to control all business decisions, share management responsibility with one or more people, or have a small group or panel of advisors to help make decisions? Also, would you like management of the business to be flexible or more rigid and precise?
Ease of Formation: Do you want to start operating immediately without filing several sets of paperwork, paying fees and waiting for review and approval from one or more states?
Taxation: Do you want corporate taxation or would you benefit from partnership “pass-through” taxation
Continuity of Existence: Do you want the business to continue on after you retire or pass on?
Liability and Financial Risk: Do you have personal assets that you need to protect from the possible liability that comes with owning and operating a business? Do you need to create a level or separation or “veil” between the business and your personal assets?
Transferability: Would you like to have the ability to transfer, assign, pledge, or otherwise utilize the ownership interests in the business?
Ability to Raise Funds: In the future, if the business needs financial assistance to expand operations, would you like the ability to raise funds through the sale of securities or ownership interests?
So taking those into account, which entity is right for you? Sole Proprietorship? LLC? Partnerships? Corporations?
Let’s take a brief look at some of the options.
Sole Proprietorship – This is the simplest and easiest to form a business structure. You do not need to file any paperwork with the state, you simply begin conducting business, and it exists. It can only be owned by one person, who will report the profit (or losses) from the business on their personal tax returns. By far the biggest disadvantage is that a sole proprietorship does not shield your personal assets if your business fails and cannot meet its liabilities. Because of unlimited personal liability, you are liable for the debts and obligations of the business, alone, and to the full extent of your personal assets.
Limited Liability Company – An LLC is a popular entity created by state law that is owned by one or more members. Without an election otherwise, it is taxed as a partnership, with the profits (or losses) passing through to the members. Since tax laws vary from state to state, an advisor can help determine whether you’d be better off forming an LLC for the potential benefits pass-through taxation can provide. One of the benefits of an LLC, as opposed to a corporation, is that you have some flexibility as to how you want the company to be managed. You can set up the LLC to be member-managed, manager-managed, or even managed by a board of managers. All of these terms are outlined in the LLC’s Operating Agreement signed by all the members. One big advantage of an LLC is that it allows for flexible management and pass-through taxation while allowing for limited liability for its members.
In most states, California included, it is unsettled whether the assets of a single-member LLC are protected from personal creditors and vice versa. The IRS considers a single-member LLC as a disregarded entity, but California requires additional fees and taxes. It’s critical to fully understand all the obligations and implications.
Partnerships – Many choices exist, including General Partnerships (GPs), Limited Partnerships (LPs), and Limited Liability Partnerships (LLPs). Simply put, each involves two or more people who agree to finance and operate a business, sharing its profit or loss. In some cases, when it comes to management, two heads are better than one.
But partnerships also make it necessary to protect one business owner from the actions of the owners. You should incorporate limited liability considerations in your Partnership Agreement in order to help shield personal assets from company assets and shield the owners from each other.
Corporations – These entities are best suited for those seeking more formality in management structure and significant liability protection. They are owned by shareholders, managed by the Board of Directors, who delegate the day-to-day management to the executive officers. To form, you must file Articles of Incorporation, draft Bylaws and other filings. Thereafter, you must be sure to hold annual shareholder and board of director meetings to maintain compliance, making them tedious to establish and complicated to maintain. There’s a much higher duty owed to the public from corporations in California. As an example, it’s codified you must have certain minimum insurance in place to ensure the public is kept safe from potential malpractice.
C-Corps[1], in general, are a good choice to protect assets. S-Corps[2] have favorable tax implications since they allow pass-through of profit taxability to individual shareholder at their own ordinary income-tax rate, with no double taxation; similar like sole proprietorships and LLCs.
Preparing Your New Business for Success
Starting a new business can be an intimidating exercise. No one person has all the answers. The experts at Jacko Law Group, PC can work with you to choose a business entity, to address areas of concern, and help sidestep potential landmines on your new path. Peace of mind can be priceless. Learn more about how we can assist you by calling us today at (619) 298-2880 or by visiting us online at jackolg.com.
[1] Meaning subchapter “C” of the Internal Revenue Code.
[2] Meaning subchapter “S” of the Internal Revenue Code.
