Congratulations, you have a million-dollar idea! You've decided to put that idea into action, but where do you start? Whether you are new to the business world, or the reincarnation of Sir Richard Branson, navigating through the legal landscape can get a little tricky. Lucky for you, I have helped many people navigate the legalese when forming a business and developed this brief guide to help you along your journey. Let's get started!
Officially forming your business
To begin, you will first need to decide what type of business to form. There are a few types to choose from, including Sole Proprietorship, Limited Partnership, Limited Liability Partnership, Limited Liability Company, S-Corporation and Corporation.
This is the most simplistic business type. In fact, if you begin conducting business without filing, a Sole Proprietorship is the default classification. There are no costs to start, and there is not a tax liability when transferring assets between the business and yourself, because the business and you are one-and-the-same in the eyes of Mr. Taxman. On the down side, since there is no distinction between you and the business, you take on all of the risks of the business without any protections for your personal assets.
Limited Liability Partnership (LLP)
In a Limited Liability Partnership, owners share in the earnings and losses of the business. For tax purposes an LLP is a pass-through entity, meaning the tax benefits and liability pass through to you and your partners individually, avoiding double taxation. However, you, the owners, are personally accountable for debts and obligations of the partnership, as well as for liabilities created by the conduct of other parties. Meaning, if your partner screws up, you could be on the hook too. LLPs are limited to professional partnerships that provide professional services, such as accountants, doctors and lawyers.
Limited Partnership (LP)
Like an LLP, Limited Partnerships are treated as pass-through entities for tax purposes. This type of structure can work well in the context of real estate and venture capital. Particularly, where you need the benefits of partnership taxation and where the managers need to be vested with complete managerial discretion over the funds provided by investors. One of the cons to an LP is that general partners are exposed to unlimited personal liability. Most of the benefits of an LP can also be found in an LLC, discussed next, without opening you to personal liability.
Limited Liability Company (LLC)
A limited liability company is a business entity consisting of one or more member owners. It is relatively inexpensive to form and like an LP and LLP is a pass-through entity for tax purposes. Generally, if all of the LLC rules are followed, each member of the LLC is protected from personal liability for the debts and obligations of the LLC. The operation of the LLC and the relationships between LLC members are controlled by an Operating Agreement. This provides quite a bit of flexibility to the owners, giving you options on how to share profits, losses, and management of the LLC in whatever way you desire.
S Corporation (S Corp)
An S Corp allows for investment opportunities, continuous existence and protection of limited liability. But, unlike a C Corp that must file quarterly taxes, S Corps only file yearly. They are not subject to double taxation and the owners report their share of profit and loss on individual tax returns. But be careful, mistakes regarding filing conditions can unintentionally result in the termination of S Corp status. Unlike the C Corp and LLC, you must be a legal resident of the U.S. to form an S Corp. As an S Corp, the company can attract investors through the sale of shares of stock, but you may not have more than 100 shareholders. Payments to employees and shareholders could be distributed as either salaries or dividends. Each is taxed differently, which is what leads the IRS to examine that distribution more closely.
Corporation (C Corp)
A C Corp offers unlimited growth potential through the sale of stocks, which means you can attract some very wealthy investors. Plus, unlike an S Corp, there is no limit to the number of shareholders a C Corp can have. However, once the company has $10 million in assets and 500 shareholders, it is required to register with the SEC. As owners of the corporation, shareholders have no direct control over the management of the business, but they are the ones that elect a board of directors to manage and run the corporation. The directors make all major business decisions such as hiring and firing officers. The officers are the employees of the corporation that handle the day-to-day operation of the business. Corporations typically have Bylaws which direct how the corporation is to operate. A corporation can be expensive to form and maintain compared to other business types. Usually, shareholders, directors and officers do not have personal liability for the debts and obligations of the corporation. If the business fails, the shareholders only stand to lose their investment. A corporation is a taxable entity, and the income earned by the shareholders is also taxable, thus creating double taxation.
Filing the paperwork
To form one of the associations listed above, documents must be filed with the Secretary of State. Here are links to the Secretary of State websites for each of the states in the Old National footprint:Indiana Secretary of State
Kentucky Secretary of State
Michigan Secretary of State
Wisconsin Secretary of State
Minnesota Secretary of State
Some business structures also require a Federal Tax ID Number or an Employer Identification Number (EIN). The IRS website provides more information about applying for an EIN.
Before starting a business, it is best to consult with an attorney. They will provide guidance based on the type of business you are forming and the state in which you will be operating.
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