So you’re starting a business. You’ve got that great idea, or you’ve found that perfect piece of property, and you want to make sure that you do everything perfectly out of the gate. First of all, pat yourself on the back for taking the right approach – a stitch in time truly does save nine. Now, to the all-important first questions: 1) Do I need to bother forming an entity – can’t I just proceed under my own name? 2) If I do need to form one, which entity should I pick for my new venture?
The short answer to each question is:
1) Almost certainly yes; and 2) It depends (read on).
Why form an entity at all? Well, simply put, because conducting your business under your own name (also known as “sole proprietorship”) puts you at serious risk of personal liability, and it might preclude you from certain tax benefits available to business-owners. Going into business as a sole proprietor means that any debts or liabilities you incur, including a judgment against your venture in a litigation, would be collectible against your personal assets. On the tax side, using a business entity opens up the range of tax credits and deductions available to you that would otherwise not be available if you operated as a sole proprietor.
So, what type of entity should you form? This depends on what you’re trying to accomplish. We see a number of folks who, when going into business with other people (as is often the case with most businesses), default to a general partnership. These are relatively easy to form, and do not need to be registered with any government authority. But, that’s where the advantages end. The chief problem with general partnerships is that each partner is personally liable for the debts & liabilities of the partnership. This means the partners are exposed to potentially huge personal losses from risks such as a market reversal, dodgy business dealings by the other partners, or simply poor business decisions.
This leaves limited liability companies (LLCs) and corporations (typically C-Corporations). Of these, LLCs are the most common for small-to-medium sized businesses for a few reasons. First, they’re easier to set up as they are less regulated than corporations. Second, they’re cheaper to set up and administer because there are fewer required governing documents and government approvals. Thirdly, LLCs, in most instances, are only taxed once – as pass-through income to their respective members. Corporate dollars, on the other hand, are, in most instances, taxed twice: once at the corporate level, and then again upon being remitted as distributions or dividends to shareholders.
All things considered, we recommend LLCs for their simplicity and flexibility. But, each situation should be carefully examined on its own merits in order to determine the best course of action. Other important questions still must be addressed, such as: where to set up the entity, and how to take advantage of multiple entities in best structuring your investments. Are you facing a similar situation, or have you faced one in the past? Reach out to us at Phocus Law. We’d love to help!
by Michele Leonelli, Attorney, Phocus Law