By Nellie Akalp, Special for USDR.
As a startup owner, your schedule is undoubtedly teeming with important decisions and long hours spent building a brand, product, client base, and organization. However, no matter how busy your days get, don’t overlook the legal aspects of your business. Particularly when the simple task of incorporating or forming an LLC for your startup can be critical to protecting your business and your personal savings.
While many startups consider themselves too small for incorporation, this couldn’t be further from the truth. Here are the key reasons why incorporating or forming an LLC are a smart move for businesses of all sizes:
- Liability protection: First and foremost, the LLC and Corporation protect the owner’s personal assets from any liabis lity of the company. That is, if your company happens to be sued, your personal assets are shielded from any judgment. Of course, lawsuitare worst-case scenarios and there’s a slim chance you’ll ever run into legal problems. However, if you’re sued as a sole proprietor, you’ll be sued personally. And that means everything – from your children’s college fund to your retirement savings – is at risk. Also keep in mind that creditor judgments can last up to 22 years, so you need to worry not only about protecting the assets you have today, but the assets you’ll have tomorrow.
- Taxes: Federal income tax rates can be lower for corporations than for individuals. And as a corporation, you may be entitled to additional deductions.
- Credibility: Adding LLC or Inc. after your company name boosts your credibility in the eyes of some customers and partners.
- Business credit/capital: As a corporation or LLC, it can be easier for you to access a line of business credit. And forming a C Corporation will be essential if you plan to seek Venture Capital funding.
What Business Structure is Right for Your Business?
Your choice in legal structure can impact the taxes you pay and how much paperwork you’ll have to contend with. The three most popular business structures in the U.S. are the LLC (Limited Liability Company), S Corporation and C Corporation:
- Limited Liability Company (LLC): An LLC is a hybrid of a partnership and corporation. There are no shares. An LLC’s main benefit, as the name suggests, is to limit the liability of the owners (separating your personal property from company property). An LLC does not file separate taxes; all company profits flow through to the owners and are taxed at the personal income rate.
- C Corporation: A C-Corporation also known as a “C-Corp” or also sometimes referred to as a “General-For-Profit (GFP) Corporation is a legal entity. There are strict requirements to form and dissolve it. A C-Corporation can earn money, take out loans and be sued (again, this is a major benefit, since liability shifts from the owners to the corporation itself). A C-Corp is taxed separately and the company must file its own tax returns. And a C Corporation can attract investors and earn capital by issuing stock.
- S Corporation: An S Corporation actually starts off as a C-Corp and then soon after incorporation, the owners submit Form 2553 to the IRS to be treated as a pass-through entity. Like a regular corporation, an S Corp is a collection of stockholders who share company ownership. But in this case, the income/loss of the company is passed through to each shareholder’s personal tax statement.
So back to the heart of the matter: which business structure is right for you? Much will depend on how much formality you want. An LLC is great for businesses that want legal protection, but minimal formality — i.e. no exhaustive meeting minutes or addendum filings. It’s also the perfect structure for a start-up who will have foreign owners. An S Corporation is great for a small business owner who can qualify: The IRS places limits both on the number of owners and on who can be an owner in an S Corporation. A C Corporation should be used for those businesses that plan to reinvest their profits back into the company or seek venture capital funding.
Where Should You Incorporate or Form Your LLC?
Delaware and Nevada are both popular states for incorporation. Delaware offers some of the most flexible, pro-business statutes in the country and Nevada offers low filing fees, as well as the lack of state corporate income, franchise, and personal income taxes. However, as a general rule of thumb, if your business will have fewer than 5 shareholders, it’s best to just incorporate in the state where you actually live or have a physical presence. Otherwise, any benefits of Delaware and Nevada will be eroded with added fees and paperwork created by ‘operating out of state.’
How Do You Incorporate or Form an LLC?
In most cases, you set up an LLC or Corporation with the secretary of state’s office for whichever state you choose as your ‘state of incorporation.’ Here’s a quick overview of the process for both the LLC and Corporation:
Forming an LLC
For an LLC, you’ll need to file Articles of Organization or Certificate of Organization with your state’s secretary of state. While the LLC is less formal, these documents must contain at least the minimum requirements as described by state law before they can be successfully filed (and your LLC processed).
Forming a Corporation
To form a corporation, you’ll need to take the following steps:
- Draft “Articles of Incorporation” or “Certificate of Incorporation”
- The Articles of incorporation must be executed by a person designated as “incorporator.” The incorporator must be an adult and doesn’t need to be affiliated with the corporation in any way other than merely filing the document. Later, this person will pass a resolution assigning all rights and duties to the board of directors.
- Submit your articles of incorporation. In most states, the agency responsible for corporate filings is the Secretary of State (usually the Corporations Division).
- Once the state office has processed your documents, they will return the certified documents to the address provided.
- Elect a board of directors: The Incorporator executes a corporate resolution electing a board of directors assigning all rights and duties to the board.
- Issue shares: The Board of Directors issues shares to designated shareholders.
- S-Corp: And lastly, if you want the pass-through tax treatment of an S-Corp, you’ll need to file IRS Form 2553 with the IRS within 75 days of the start date of your corporation.
When Should You Incorporate or Form an LLC?
As for timing, since the main benefit of incorporation is liability protection, the sooner you incorporate or form an LLC, the better. There’s simply no reason to wait and potentially expose yourself to any more liability than you need to.
Most importantly, the act of incorporating a business or forming an LLC won’t break the bank, particularly if you use an online legal filing service or file the forms yourself. Whatever method you choose, make sure to pat yourself on the back for taking this important step for your business and your finances.
Nellie Akalp is a passionate entrepreneur, small business advocate and mother of four. As CEO of CorpNet.com, a legal document filing service, Nellie helps entrepreneurs start a business, Incorporate, Form an LLC, or set up Sole Proprietorships (DBAs) for a new or existing business.