Incorporating a Company
Welcome to the startup
guide for incorporating and forming your own company, designed for those individuals considering going into business for themselves. First thing you need to know is that you are not alone. The shift from large companies
to smaller companies is a trend that has been underway for many years, and the shift is due to many factors, including large company layoffs, veterans returning to the work force, people looking for a second income, and those just excited to provide a product or service that fills a need in the market. Being your own boss can be a rewarding experience.
This startup guide provides useful information to incorporate and form a company as a sole proprietorship, general partnership, limited partnership, LLC, or corporation. Learn the differences between the various company forms, as well as some advantages and disadvantages of each. This includes a list of essential resources for you to get started.
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One of the most important decisions that you will make regarding the start of your new business is choosing the legal form of ownership that is right for you. Why is this important? This is an important choice as each legal form of ownership has its own advantages and disadvantages, and these must be investigated thoroughly to make the right choice. In addition, these advantages and disadvantages can change over time as a result of federal and state laws, particularly with respect to taxation and liabilities of your business.
Ok, now the important part that our lawyers made us add: this overview is not meant to be a comprehensive exploration of all the various forms of business and implications, and it is not intended to be legal advice in any way. We strongly encourage you to seek legal counsel to help you go through these choices in more detail. Laws that govern legal entities of a business can include city, state and federal and as a result it is difficult in this overview to provide a comprehensive guide for each. Once you decide what form of legal entity you desire, there are many websites that can provide you with legal forms, contracts, and documents that can help you to reduce costs to establish that legal entity. You are also strongly encouraged to consult a tax specialist, and the overview presented here is not meant to be tax advice.
Ok, with that out of the way, lets get started. The choice you make of legal entity will affect your personal liability, management and taxation. In broad terms, there are 5 forms that a business can take, and we will talk briefly about each. The five forms are:
• Sole proprietorship
• General partnership
• Limited partnership
• Subchapter S corporation
• Corporation or C corp
A sole proprietorship is the simplest form a business can take. Most likely 75% of all small businesses are in this category as it is easy and simple to set up. Usually this is nothing more difficult to set up than picking a unique name for your business and going to your local city clerk's office to register that name. In addition this is probably the least costly form of business to set up. Advantages of this legal form include one person having control, one person responsible for funding the business, and one person making all the decisions. The owner basically has all the control in managing the business.
All that sounds good right? Now here are some of the disadvantages: banks will probably not want to make a loan to you as if something happens to you, the owner, the business fails; if someone decides to file a lawsuit against the business, you are personally liable and all your assets (such as your house, etc) are at risk; if this business falls into debt, creditors will come after your personal assets; and your business income is the same as your personal income for tax purposes, which may put you in higher tax brackets, therefore having to pay more taxes. So as you can see while it is easy and cheap to set up, there are some things you have to consider in this decision.
General partnership is the simplest legal form used when you have two or more owners of a business. This differs from a sole proprietorship as now multiple owners pool their money to fund the business, share the workload and decisions, and bring in experience to the business from multiple people. You share everything. You would still go to your local county clerks office to get the business set up, but in this instance you would let them know that there are multiple owners of the business. This form of business will make it easier to get funding for the business, as now there is less risk in making a loan with multiple partners.
Some of the disadvantages of this form of business are: you still have unlimited personal liability for anyone that files a lawsuit against the business, although it is now split among all the owners of the business; it can be more difficult to make business decisions in that now all owners will need to be consulted to make a decision; if one of the owners dies it could terminate the partnership and dissolve the company if this stipulation was not provided for in the startup legal documents. So it can be great to share the responsibilities and costs of a business, but you also share the liabilities and of course all the profits!
The limited partnership is the next step to consider as it moves one step closer to a corporation than a general partnership. How does this help? It helps when you try and raise money for the business. For example, one or more partners could be the one running the business, with additional partners only providing funding and not direct control over the operations. So this allows you to have investors, but not lose day-to-day control over managing the business. Setting up a limited partnership requires more legal paperwork than just going to the county clerk's office and so you should consult an attorney or look at the online forms from legal advisory companies.
Another hybrid approach that is very popular is the Limited Liability Company, known as an LLC. This is a hybrid or blend between a corporation and a sole partnership or limited partnership (depending on the number of owners). The LLC needs to be set up usually with the state, and its benefit is that the owner or members can shield themselves personally from acts or debts of the company (depends on the state laws governing this) while at the same time taking the income from the LLC as personal income on your tax forms.
One of the disadvantages is that lenders may require a personal commitment on a loan since they realize that, if the LLC would fail, you would otherwise escape any penalty for this commitment. Still, this is an attractive alternative.
A full corporation, which many call a "c" corporation, creates a separate legal business separated from the personal owners. A corporation can buy and sell property or even other companies, and pay its own taxes separate from the owners of the business. This generally will require help from an attorney who can guide you through the set up as there are company bylaws that need to be generated, a selection of what state to incorporate in must be made with knowledge of taxation, stock can get created... but this is also the costliest form of business to set up compared with the others we discussed. The good news is that under this form of business your assets are now generally shielded, so your personal assets are not at risk if this business fails or is under a lawsuit; the ownership in the business is transferable in case of death or sale; and this form makes it easier to raise money.
However with changing tax laws, a corporation may have higher taxes than the individual, there are requirements now for extensive records to be kept for the business, and there are different tax reporting requirements. Decisions are made within the corporation typically by directors and not anyone person has full control.
An S corporation is very much like a "c" corporation but is a blend of corporation and partnership. The biggest differences come in the areas of taxes and liability. In the area of liability, the owner has the shielding of personal assets like a "c" corporation, but taxes are viewed as more personal and not separated as a traditional corporation. There are several other differences such as the number of shareholders is more limited than a corporation, only one class of stock is available (not multiple classes like reserved stock, common stock, etc). Remember that another important difference is that profit and losses flow through to the group of shareholders of the company.
So we hope that we have helped you to better understand the 5 legal forms a business can take, and that you now have a better understanding of the advantages and disadvantages of each. You should also be aware that while this decision is important any number of reasons as we have seen, it is not uncommon for a business to start as a sole proprietorship and later move to a limited partnership and then still later to a "c" corporation. This movement is warranted as the business becomes larger, the owners want to eliminate more personal liability and risk, and also to take on more shareholders or partial owners.
For more information, check out these websites:
• Comparison table of business structures:
Sample forms for each business structure (what you will need to form your company):
Business attorneys and legal services listed on 40billion.com:
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