Whether you want to take that hobby and turn it into a full-time job or have a brilliant idea that you’re developing that’s going to change the world, one of the first things you need to think about is what form of business entity makes the most sense for your short and long-term goals.
Why is that so important? Every business owner should be concerned about minimizing his/her exposure to risk and liability as an individual for debts and obligations of his/her business. If you create a separate business entity, you can separate your personal assets from the assets of the business and therefore shield yourself from most claims made against the business.
In order for you to achieve this liability protection, you will need to file the appropriate paperwork with the state where your principal place of business is located and one that has laws you’d like the business to be governed by. The two most common entity forms that provide you with liability protection include a limited liability company (LLC) and a corporation. And, depending on what your short and long term goals are, you will likely select the one which offers the desired structure and management of your business as well as the tax treatment you prefer.
In terms of structure and management, you’ll need to think about whether you want a more flexible or traditional format. Limited liability companies provide great flexibility because you can set up your company to be managed by all of its members (or owners) or by one or more managers. You can even have the company managed by a non-owner so specific individuals with certain expertise perform the management responsibilities.
The structure and management of an LLC is governed by the company’s operating agreement and the applicable state LLC rules. The operating agreement sets forth how the company will be run and managed and is a critical document that should be put in writing. Even if you’re a solopreneur, it’s important to be clear on the company’s protocol for day-to-day operations, membership interest, and what occurs in the event the member or owner becomes disabled or dies. These are all important considerations that should be addressed in writing, among others.
The LLC provides for flow through taxation, meaning that taxable income earned by the company is passed through to individual members and therefore the company is subject to one level of taxation.
For a corporate structure, you’ll typically see a more traditional format. Typically, the corporation’s shareholders elect a Board of Directors, and the Board appoints the officers of the corporation who handle the corporation’s daily operations. You can elect to be a C-corporation or an S-corporation. There are a variety of similarities and differences between the two. They both offer limited liability protection, are considered separate entities, require paperwork to be filed with the state, and share the same structure and corporate formalities. However, they are different with respect to taxes and as to corporate ownership.
C corporations are subject to double taxation, and S corporations are pass through entities and therefore are subject to one level of taxation. With respect to ownership, C corporations have no restrictions but S corporations do. Some restrictions for an S corporation include being limited to 100 shareholders who must be US citizens/residents, not being allowed to be owned by a C corporation, another S corporation, an LLC, partnership or certain types of trusts, and only having one class of stock.
For companies that are seeking outside investors, the corporate structure is often very attractive because the structure and corporate management is predictable. In the alternative, the limited liability’s structure and management is attractive because it often allows for more efficiency and less rigidity with respect to corporate formalities.
As a business strategy, selecting the best entity form for your business requires consideration of various factors. For more information on choosing the appropriate entity for your business, please contact us at 703.319.7868 or via email at grace@graceleelaw.com.