Written by Alice StevensAlice Stevens is a language enthusiast and loves learning history. She's written about travel and marketing, and currently writes content for BestCompany.com.
Starting a business takes considerable work. In addition to getting your products and services ready, writing your mission statement, and determining your marketing strategy, entrepreneurs also need to have their legal matters in order. The first step is choosing the legal structure of your business.
Deborah Sweeny, CEO of My Corporation, says “I believe that the best legal advice I received when starting up was to form a corporation or Limited Liability Company (LLC). Often it seems too difficult, too expensive, and too cumbersome, but the truth is that having your business entity with the right structure can be a benefit in so many ways.”
Of course, you can structure your business in a few ways. Corporations and LLCs are common choices.
Additionally, you can always run your business using your own name, but there are drawbacks. There won’t be a way to distinguish between your personal assets and your business’s assets. This lack of distinction puts your finances at risk in the event of a lawsuit or liability claim.
What are LLCs?
LLCs are Limited Liability Companies. They reduce the business owner’s liability and protect personal assets.
LLCs can be single-member or multi-member, which is handy for people interested in going to business with partners or by themselves.
LLCs are less regulated than other types of businesses. Specific rules for LLCs vary state to state. LLCs are not subject to corporate taxes. Instead, each LLC member pays taxes on their share of the profits in their individual taxes.
Individuals who form an LLC do not have to be U.S. citizens or permanent residents.
To form an LLC, you must file Articles of Organization that describe how your business will be managed within the state that you will conduct business. You will also need to get ID numbers from the IRS and other government agencies for tax purposes and unemployment.
What is an operating agreement?
An operating agreement sets forth how an LLC will deal with situations like the death of a business partner, partner being bought out, or a partner leaving the business.
State laws also govern these issues in the absence of an operating agreement. However, an operating agreement gives all LLC members more control and options over how things will operate.
What is a corporation?
Like an LLC, a corporation protects personal assets by limiting a business owner’s liability for company debts.
The major difference between an LLC and a corporation is the ability to open the company to investors. Setting up your business as a corporation allows a business to become publicly traded on the stock market.
Owners also have shares in the company. Often, the more shares owners have, the more control they have over the decisions.
To set up your company as a corporation, you’ll need to file Articles of Incorporation and apply for necessary ID numbers from government agencies. A corporation can be non-profit or for-profit. If the corporation is non-profit, the profits from the stock market are not given to the owners.
What are bylaws?
Like LLCs, corporations can determine the terms of separation, closing the company, buying a partner out, or divesting from the company. These are called bylaws.
However you choose to set up your business, you can hire an attorney to take care of the paperwork for you, or you can do it yourself with the aid of online legal services.
Getting it Right
When choosing your company’s legal structure, think about your business goals and how you want your business to grow. This will help you decide the appropriate structure for you business.
Jesse Silkoff, Co-founder and President of FitnessTrainer.com and MyTennisLessons, started a business as an LLC. He says “Having an LLC structure worked just fine for the first few years until we decided to raise capital from outside investors. In hindsight, if we had known at the beginning that we would definitely be raising capital from outside investors, then we would have set up as a C-Corp from the start.”
“This was an expensive mistake on our part because switching from an LLC to a C-Corp in order to take on those outside investors was both time consuming and costly,” Silkoff says.
Silkoff is not alone in having to change the legal structure of his business. Zach Hendrix and Gene Caballero, Co-Founders of GreenPal, had a similar experience.
Caballero says, “When we first started, we were legally advised that we only needed to incorporate as an LLC — which is totally inaccurate. When we attempted to raise an angel round, they practically laughed at us because we were not a C-Corporation.”
“We had to pay a specialist attorney to dissolve the old LLC and very carefully assign everything to the new proper entity which is a Delaware C Corporation,” says Hendrix.
“This cost us our first round of funding because we had to change our status and was a $12,000 mistake that almost cost us our business,” says Caballero.
Investing to ensure that you have the right legal structure from the beginning can save you money down the road. It can also set your business up for success in other ways.
Sweeny says, “When you are looking for a business loan, having a properly formed entity is a critical step. Having your business established is also important when looking for contracts, working with partners, and also hiring. It is an important first step — and getting set up right and early can also help establish business plans and strategies and open up communication with your partners.”