To start or not to start....a business?
According to a Nate Hindeman's article in the Huffington Post, fifteen percent of entrepreneurs launched their own ventures after losing their job and that number jumped to as high as eighteen percent in the last twelve months.
I received a tweet several weeks ago from a follower who wants to start a business but was held up on what type of entity to start. In other words, "Should I form a LLC or an S-corp? What's the difference between them and a sole-proprietorship?"
This is a common question and the answers can differ depending on who you ask. So I asked an expert, Nellie Akalp who is the founder of CorpNet, an online legal document filing company based in California.
1. What's the importance of forming a legal entity? Why should I bother and can't I just operate with a D/B/A?
Choosing your business' legal structure is a critical decision, as it can impact many facets of your business.
One of the main reasons I find that entrepreneurs want to incorporate their business is because of Liability protection. Once you incorporate your business, it exists as a separate legal entity. The corporation is responsible for all of its debts and liabilities and not you, the person. There are a lot of 'What-Ifs' when starting a business, and being protected from all of those situations will give you some sign of relief if you are ever in trouble.
There are also tax benefits once incorporated. Taxes can be an entrepreneur's worst enemy. But for some, incorporating can help lower that tax burden and may enable additional deductions not available to individuals.
In addition, marketing studies have shown that adding a LLC or Inc to the end of your company name can increase your credibility with prospective clients. Increased credibility can bring in more business and that should make any entrepreneur make the plunge to incorporating!
2. What's the major difference between an S-corp, LLC, partnership and a sole proprietorship?
There are a few differences between each structure that is important to know. Here is a rough outline:
Sole Proprietor - This type is based on personal ownership. Property and liabilities are held in someone's name. This can be either an individual (normally) or a married couple. Home businesses often use this type. It is simple and cheap. Business taxes are filed as personal income. Liability is also personal, which is a disadvantage. In most areas, starting a sole proprietorship is as easy as filing a DBA (Doing Business As). Some locations (and types of businesses) may require other licensing. Fees are minimal. Required records are similar to personal tax records.
Partnership - The most basic mirrors a sole proprietorship. The key document is the partnership agreement. This spells out the division of ownership. In a General Partnership, the responsibilities are shared across partners. Management duties and profits are shared as well. There are no direct taxes on a partnership; taxes are handled as personal taxes on each partner. There are other, special types of partnerships. These are more like corporations. Limited Liability Partnerships, Professional Partnerships and Limited Partnerships give more flexibility and alter liability.
Corporation (C Corp) - This is a more complex legal structure. The key difference is that a corporation is a legal entity separate from its owners. Ownership is through stock in the company. Stock may be privately held or public. The ability to offer stock for sale is an advantage. It allows for financing outside of direct loans. Another advantage is the protection a corporation offers by limiting liability. Startup costs are higher with a corporation. There are more formalities and regulation issues. Taxes are also business based instead of individual.
S Corporation - This subtype of corporation has one advantage over a C Corp. Taxes are paid like they are for partnerships. IRS requirements must be met, but the S Corp taxing method is a benefit. Other advantages of a C Corp are retained.
Limited Liability Company (LLC) - This form combines the advantages of a corporation and those of a partnership or sole proprietorship. It doesn't require the formal structure of a 'real' corporation, but still limits owner liability. Taxes are done as they are for a partnership (or sole proprietorship). One disadvantage is the inability to issue stock to raise capital.
3. Is picking a name really that important for my business?
Choosing a name is a very important step of starting a business. The trick with choosing a name for your business is to make sure that name is available to use before you get your heart set on it. Before you dive in too far with your branding, you need to make sure that the name isn't infringing on the rights of someone else's business. This isn't a complex process -- you don't need an attorney. In seconds, you can perform a free trademark search to see if your name is available to use in the U.S.
Name conflicts are one of the main reasons many LLC or corporation applications get rejected. By checking to make sure your name is available, you'll have the peace of mind of knowing that your state or county processing office won't reject your LLC, corporation or DBA registration because the name is already in use.
4. I'm thinking about partnering with a friend for a business. What issues should we be concerned with?
Partnering with someone you know can be a great way to launch a business, but mixing business with family and friends can also be tricky.
When partnering with a long-time friend, colleague or family member, it is important to remember that although you may have complete trust in one another, it is vital to still focus on formalities and paperwork upfront at the beginning of your business relationship.
In any business arrangement, issues are bound to arise. Maybe you'll disagree over how to spend your marketing budget; maybe your partner's personal situation will change and he or she will need to return back to an office job. If you haven't discussed how some of these important decisions will be made upfront, you can end up in a very difficult position.
By discussing all these investments, no matter how minor, from the start, you can make sure that everyone feels like their contributions are valued and recognized.
5. Can I form a LLC without a partner?
Absolutely! A single member LLC is a business structure that emerged in the 1990s. Over time, it has become recognized in all States. As the name implies, an SLLC has a single owner so you do not need a partner. Because income from an SLLC isn't divided (as it would be for a partnership or a multiple member LLC) there are no separate taxes to file with the IRS. The IRS treats an SLLC just like a sole proprietorship. (This isn't necessarily true for State level taxation).
As always, please comment below!
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