This is a guest post by Scott Walker: Before you start your business, you need to create a corporate entity. And although it seems simple, it really isn’t. Because of this I asked Scott Walker from Walker Corporate Law Group if he could do a guest post about choosing the right corporate entity. So here goes…
One of the most important early decisions an entrepreneur must make in connection with his or her venture is the choice of entity. There are basically six choices:
- Sole proprietorship
- General partnership
- Limited partnership
- C corporation
- S corporation
- Limited liability company
Below is a discussion of each entity, including a basic description, its advantages and disadvantages, the ideal candidate/business for such entity, the cost to set-up such entity and the most important take-away.
1. Sole proprietorship
A sole proprietorship is the simplest, most common way of organizing a business. A sole proprietorship is not a separate legal entity; it is a business owned and run by one person (hence, the term “sole”). For legal purposes, there is no distinction between the business and the sole proprietor.
What are the advantages?
The significant advantages of utilizing a sole proprietorship include:
- Ease of formation – the owner does not have to file any formation documents with governmental agencies (other than perhaps a simple fictitious name or “DBA” certificate if it is doing business under a name other than the owner).
- Very inexpensive – since there are no organizational documents, there will be no legal fees for drafting documents and no filing fees (other than for a DBA).
- No double taxation – unlike a C corporation, the business and the owner do not pay income taxes separately; indeed, all income taxes are handled on the owner’s personal tax returns.
What are the disadvantages?
The significant disadvantages of utilizing a sole proprietorship include:
- Unlimited personal liability – this is the biggest problem with a sole proprietorship. The owner will be held personally liable for all of the business’s activities, including its debts and liabilities.
- No equity issuances – a sole proprietorship is by definition owned by one individual; accordingly, the business cannot issue equity (e.g., stock options) to a key employee or to an investor.
- No continuity of existence – upon the death or incapacity of the owner, the business ceases to exist.
Ideal for whom?
A sole proprietorship is ideal for someone who wants to start a one-person business quickly and inexpensively, and such business will not be seeking outside investment and has limited liability exposure; e.g., a service provider like an accountant would be an ideal candidate – particularly if he or she can buy insurance to protect against any malpractice claims.
How much does it cost to set-up?
There is no cost for setting-up a sole proprietorship, other than the cost of filing/publishing a DBA certificate (approximately $50 to $75).
What’s the most important take-away?
The most important take-away is that sole proprietorships have very limited utility for entrepreneurs and should generally be avoided due to the unlimited personal liability and lack of structure for equity issuances.
2. General partnership
A general partnership is an association of two or more individuals (or entities) to conduct a business as co-owners.
What are the advantages?
The significant advantages of utilizing a general partnership include:
- Ease of formation – like a sole proprietorship, there are no formalities required to form a general partnership (though a few states require a simple filing at the county level and a DBA certificate may be required); in fact, a general partnership can be formed without a written agreement between or among the partners – though it would be prudent to have one.
- Relatively inexpensive – since there are generally no formalities to form a general partnership, it is less expensive than other entities – both initially and on an ongoing basis; however, there will be legal fees associated with the drafting of a partnership agreement.
- Separate legal entity – in most states, a general partnership is a separate legal entity, with partnership interests that can be issued and transferred, and the partnership can own real estate and other property in the partnership name.
What are the disadvantages?
The significant disadvantages of utilizing a general partnership include:
- Unlimited liability – every partner in a general partnership assumes unlimited liability for the partnership’s debts and liabilities, including any tortious acts committed by a co-partner during the ordinary course of partnership business; obviously, this is a huge potential problem if the partners are individuals – it’s like a sole proprietorship on steroids.
- No outside investors – from a practical standpoint, the business will not be able to raise capital from outside investors because investors will not want to be a general partner and subject themselves to unlimited liability.
- Fiduciary obligations – each partner has a fiduciary obligation to the other partners with respect to all matters affecting the business – which is an extremely high standard requiring undivided loyalty, good faith and fair dealing; this standard has led to a lot of litigation among partners and allegations of conflicts of interest and self-dealing.
Ideal for whom?
A general partnership is ideal for two or more individuals who wants to start a business quickly and inexpensively – particularly if the business will not be seeking outside investment and has limited liability exposure; e.g., an accounting firm or a law firm would be an ideal candidate.
How much does it cost to set-up?
As noted above, a general partnership is relatively inexpensive to set-up. There are generally no filing fees, other than a DBA certificate (approximately $50 to $75); however, there may be legal fees associated with the drafting of a partnership agreement (approximately $1,000 to $2,500).
What’s the most important take-away?
The most important take-away is that (like sole proprietorships) general partnerships have very limited utility for entrepreneurs and should generally be avoided due to the unlimited personal liability of the owners.
3. Limited partnership
Like a general partnership, a limited partnership is an association of two or more individuals (or entities) to conduct a business as co-owners; unlike a general partnership, however, there are two kinds of partners: general and limited. A general partner’s liability is unlimited, and a limited partner’s liability is limited to the amount of his or her investment in the business (hence the term “limited”). The business is managed by the general partner(s).
What are the advantages?
The significant advantages of utilizing a limited partnership include:
- Limited liability – as noted above, the number one advantage of a limited partnership is that the limited partners do not have unlimited liability (such as in a sole proprietorship or a general partnership); again, a limited partner’s liability is limited to the amount of his or her investment, subject to the caveat below (i.e., if a limited partner participates in the control of the business, he or she could be deemed a general partner).
- Facilitates outside investors – a limited partnership is a good vehicle for raising capital because the investors become limited partners and thus have limited liability, and the limited partnership interests/units can be easily transferred.
- Pass-through tax treatment – assuming all of the required formalities have been complied with, a limited partnership’s profits and losses flow directly to the individual limited partners (the entity itself is not taxed, as in a C corporation), which is desirable in certain ventures.
What are the disadvantages?
The significant disadvantages of utilizing a limited partnership include:
- Unlimited liability for general partners – every general partner has unlimited liability; accordingly, in most limited partnerships, the general partners are corporations or limited liability companies in order to shield against personal liability (which creates a complex and expensive structure).
- Creature of statute – unlike a general partnership, a limited partnership is a creature of state law; accordingly, a certificate of limited partnership must be filed with the applicable Secretary of State and, in some states (including California), a written limited partnership agreement must be executed.
- Limited partners may not participate in management – if a limited partner “participates in the control of the business,” he or she could be deemed a general partner and be subject to unlimited personal liability; in certain states, it is unclear what activities constitute “control”.
Ideal for whom?
Limited partnerships are ideal for businesses that focus on a single or limited-term project (e.g., a real estate project or a film production project) or for so-called “labor-capital” partnerships, where one partner or set of partners (the general partners) do the work and the other partners (the limited partners) provide the capital (e.g., a private equity firm or hedge fund).
How much does it cost to set-up?
The costs for setting-up a limited partnership are going to be more than for a partnership because a certificate of limited partnership must be filed with the applicable Secretary of State and a limited partnership agreement must be executed. Accordingly, there will be filing fees of approximately $250 to $600 and related legal fees for drafting such certificate and the limited partnership agreement of approximately $1,000 to $3,000. Obviously, there will be additional costs if the general partner is an entity, not an individual.
What’s the most important take-away?
The most important take-away is that limited partnerships have limited utility for most entrepreneurs due to their complexity and the unlimited liability of the general partner(s).
4. C corporation
A corporation is a separate legal entity created under state law, with a legal existence distinct from its owners. A C corporation is the most common type of corporation; unlike an S corporation, it is subject to double taxation — which means that first the corporation (as a separate taxable “person”) is taxed on its profits; and second, each of the shareholders are taxed on any dividends distributed to them.
What are the advantages?
The significant advantages of utilizing a C corporation include:
- Best shield against personal liability – a C corporation is the most widely-accepted and well-established entity for the protection against personal liability; accordingly, so long as all corporate formalities have been complied with, the shareholders of a C corporation will only be liable for the debts, obligations and liabilities of the corporation up to the amount of the respective investment (regardless of any management participation).
- Best entity to attract venture capital – VC funds generally invest only in C corporations (and indeed C corporations formed in Delaware); from a tax perspective, VC funds generally avoid (and may be prohibited under their respective fund documents from) investing in “pass-through” entities such as S corporations or limited liability companies, as discussed below; and from a corporate perspective, Delaware is the most common state of incorporation due to its well-developed case law, management protections and ease of corporate filings (and related administrative issues).
- Flexible capital structure – a C corporation offers the simplest and most-flexible capital structure of any entity – e.g., unlike an S corporation, a C corporation may have different classes of stock, and unlike a limited liability company, a C corporation may easily issue stock options to employees and consultants; moreover, such flexibility facilitates capital raising due to the accessibility of a broad range of financial instruments/vehicles, including preferred stock, warrants, convertible notes, subordinated debt, etc.
What are the disadvantages?
The significant disadvantages of utilizing a C corporation include:
- Not a pass-through entity – the biggest disadvantage of a C corporation is that it is not a pass-through entity; accordingly, as noted above, it is subject to double-taxation, which means that corporate profits are taxed twice and any losses do not pass through to its shareholders.
- Onerous formalities and recordkeeping – corporations are subject to onerous formalities under applicable state law, including the filing of a certificate of incorporation, the adoption of bylaws, the election of a Board of Directors, annual meetings of the Board of Directors and shareholders, the maintenance of separate books and records and bank accounts, capitalization requirements, etc.; the failure to adhere to such formalities could result in a court “piercing the corporate veil” and holding the corporation’s shareholders personally liable.
- Costly set-up and maintenance – as a result of the onerous corporate formalities noted above, the costs for forming and maintaining a corporation are relatively high; e.g., if a corporation is “doing business” in a state other than state of incorporation, it must qualify to do business there (which is like a mini-incorporation) triggering additional costs and taxes.
Ideal for whom?
A C corporation is ideal for any business that desires strong protection against personal liability and will be seeking venture capital funding, but does not need pass-through tax treatment prior to such funding (or does not otherwise meet the S corporation requirements below).
How much does it cost to set-up?
A corporation (whether it be a C corporation or an S corporation) is the most expensive entity to set-up due to all of the required paperwork and filings. Filing fees range from approximately $300 to $900; and legal fees range from $1,000 to $4,000 depending upon the extent of the documentation (e.g., a corporation seeking venture funding should execute founders stock purchase agreements and invention assignment agreements, among other things). There may also be some accounting fees (approximately $500 to $1,500).
What’s the most important take-away?
The most important takeaway is that a C corporation is the best shield against personal liability and should be the first choice of entity for any business that will be seeking venture capital funding. If venture capital funding is not imminent and the founders will be investing a significant amount of money and would like to personally write-off anticipated losses, an S corporation should be considered as well, as discussed below.
5. S corporation
An S corporation is a type of corporation; it is formed under applicable state law just like a C corporation, but an “election” is filed with the Internal Revenue Service. Accordingly, as noted above, it is a separate legal entity, with a legal existence distinct from its owners. The name “S corporation” refers to sub-chapter S of the Internal Revenue Code, under which such election is made. (“C corporations” are named and governed by sub-chapter C of the Internal Revenue Code.) Unlike a C corporation, an S corporation is a pass-through entity and thus is not subject to double taxation – i.e., profits and losses of the corporation pass through to the individual shareholders.
What are the advantages?
The significant advantages of utilizing an S corporation include:
- Effective shield against personal liability – like a C corporation, an S corporation is an effective and well-established entity for the protection against personal liability.
- Pass-through tax treatment – as noted above, the profits and losses of an S corporation flow directly through the corporate entity to the individual shareholders, which is often desirable; e.g., if founders will be investing a significant amount of cash in a startup venture and VC funding is not imminent, an S corporation may be very appealing because any losses can be written-off on the founders’ respective tax returns up to the amount of their investment (and the amount of certain corporate debt of the S corporation).
- Easy to convert to C corporation – as noted above, VC funds generally invest only in C corporations (and are not eligible to invest in S corporations in any event, as discussed below); the conversion from an S corporation to a C corporation, however, is relatively easy — unlike the conversion from an LLC to a C corporation, as discussed below.
What are the disadvantages?
The significant disadvantages of utilizing an S corporation include:
- Limitation on type and number of shareholders – the biggest disadvantage of an S corporation is that the shareholders may only be (i) individuals who are U.S. citizens or residents, (ii) estates and (iii) certain eligible trusts; and the number of shareholders is capped at 100.
- Limitation on capital structure – another major disadvantage of utilizing an S corporation is that it may only have one class of stock (except that stock with different voting rights is permitted); accordingly, an S corporation may not issue both common stock and preferred stock – and even the issuance of certain options or convertible notes could invalidate the S corporation election.
- Onerous formalities and recordkeeping – like C corporations, S corporations are subject to onerous formalities under applicable state law, including the filing of a certificate of incorporation, the adoption of bylaws, the election of a Board of Directors, annual meetings of the Board of Directors and shareholders, the maintenance of separate books and records and bank accounts, capitalization requirements, etc.; the failure to adhere to such formalities could result in a court “piercing the corporate veil” and holding the corporation’s shareholders personally liable.
Ideal for whom?
An S corporation is ideal for any business that meets the shareholder eligibility requirements and desires strong protection against personal liability and pass-through tax treatment (whether permanently or during the period prior to venture capital funding).
How much does it cost to set-up?
As noted above, a corporation (whether it be a C corporation or S corporation) is the most expensive entity to set-up due to all of the required paperwork and filings. Filing fees range from approximately $300 to $900; and legal fees range from approximately $1,000 to $4,000 depending upon the extent of the documentation. There may also be some accounting fees ($500 to $1,500) relative to the S corporation election and other accounting issues.
What’s the most important take-away?
The most important takeaway is that an S corporation is an excellent shield against personal liability and should be the choice of entity for any business that will be seeking venture capital funding if such funding is not imminent and the founders would personally like to take advantage of anticipated losses of the corporation.
6. Limited liability company
A limited liability company (LLC) is a relatively new entity and can best be described as a hybrid between a C corporation and a general partnership: it protects against personal liability like a C corporation (subject to the caveat discussed below) and it has a general partnership’s flexibility and pass-through tax treatment. Unlike S corporations, LLC’s have no limitations with respect to the eligibility of its owners (called “members”); accordingly, a corporation or another LLC may be a member of an LLC. And unlike a limited partnership, the members of an LLC may control the company and participate in its management and still be protected against personal liability.
What are the advantages?
The significant advantages of utilizing a limited liability company include:
- Extraordinary flexibility – probably the most appealing aspect of an LLC is its extraordinary flexibility, including with respect to the distribution of cash and other assets, the allocation of income or losses, etc. (all of which is generally reflected in a written operating agreement); indeed, an LLC may be operated like (i) a corporation, with a Board of Managers and officers, (ii) a general partnership, with all members appointed “managers” or (iii) a sole proprietorship, with one member (or outside individual/entity) appointed the manager; an LLC may also elect to be taxed as a C or an S corporation if it so chooses; and, in certain states (like Delaware), an LLC may even limit the fiduciary obligations of its manager(s).
- Effective shield against personal liability – like a C corporation and an S corporation, an LLC is an effective shield against personal liability, subject to one caveat: a few courts have held that a single-member LLC (i.e., an LLC with one owner) is not protected against personal liability; note: single-member LLC’s are tricky and advice from counsel is strongly recommended.
- Pass-through tax treatment – as noted above, the other major advantage of an LLC is that profits and losses flow directly through the entity to the individual members (unless, as noted above, the LLC elects otherwise – which is quite rare); as previously discussed, this can be very appealing to avoid the double taxation of profits and to permit the members to write-off certain losses of the company.
What are the disadvantages?
The significant disadvantages of utilizing an LLC include:
- Complexity – the most significant disadvantage of an LLC is its complexity, particularly from a tax and accounting perspective; LLC’s are generally governed by extremely complex partnership tax rules – which trigger pages and pages of tax provisions in the operating agreement and significant ongoing compliance costs.
- Unattractive to VC’s and other investors – as noted above, VC funds and other institutional investors generally do not invest in pass-through entities; accordingly, if a business is seeking venture capital funding, this would not be a good choice of entity; indeed, converting an LLC to a C corporation is much more difficult and expensive than converting an S corporation to a C corporation.
- Limitation on capital structure – the other major disadvantage of an LLC is that it is very difficult and expensive (i) to grant options to employees and consultants and/or (ii) to issue other types of securities, such as “preferred” membership interests (like preferred stock in a C corporation), convertible notes, etc.
Ideal for whom?
An LLC is ideal for any business that desires (i) protection against personal liability, (ii) pass-through tax treatment and (iii) flexibility with respect to distributions, allocations and/or management. Consulting firms and real estate projects are ideal candidates; also, certain private equity and investment funds that previously utilized limited partnerships are adopting the LLC structure.
How much does it cost to set-up?
An LLC can be as expensive as a corporation to set-up due to the legal and tax/accounting fees relative to the drafting of an operating agreement. Filing fees generally range from approximately $250 to $600; legal fees range from approximately $1,500 to $4,500; and tax/accounting fees could range from approximately $1,000 to $2,500 depending upon the complexity of the operating agreement.
What’s the most important take-away?
The most important takeaway is that LLC’s offer the attractive features of protection against personal liability, pass-through tax treatment and flexibility, but are not the best choice of entity for businesses that will be seeking venture capital funding.
Conclusion
Picking the right corporate entity is a very important set in the entrepreneurial journey. A bad choice could mean that you’ll be paying double the amount of taxes. Or even worse, a wrong mistake could mean that you are personally liable for the company’s actions.
So the big question is, which corporate entity is right for you?
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I’m not sure if this is the case in the US but in the UK there are additional expenses differences that affect different business entities.
I think something all businesses should consider is the perception element of different businesses entities, particularly in the B2B world. For example certain businesses are going to be more attractive to customers by being setup in a more committed formalised structure.
Thanks, I discussed the different costs above.
Really, it is a very useful post, I see many business entities opt LLC and now i actually understand the reason behind it.
sorry… what is LLC? explain please
If I’m not mistaken, this means Limited liability company
I think making a LLC is a good idea if you just want to protect yourself. But if you think that you will become huge or want to become huge then do a S or C corp.
I think it is really hard deciding when your funds are limited but again I guess you have to look at the overall goal and not just the short gains.
I don’t think an LLC offers better protection than a corporation.
Great – thanks
For a minute, I thought the guest post was from Scott Walker, the amazing singer http://en.wikipedia.org/wiki/Scott_Walker_(singer) :.)
Seriously, for anyone who is making a ton of money online and is doing so as a “sole proprietorship”, please read this and contact your accountant / attorney about changing your tax status.
The funny thing is, I know a few people who are making 50k to 100k in profit a month and they are still running as a sole proprietorship. And they don’t care to change it…
That’s scary! I’ve encountered real estate investors who didn’t structure correctly and had incidents with tenants suing for various reasons.
Could imagine losing multiple apartment complexes in different locations because you had to declare bankruptcy on a single family home that had a dangerous sidewalk and someone broke their foot… I bet they wish they could go back and spend the few extra bucks to have their holdings protected!
Why should they change it?
please explain. any advantages if they change it? I really would like to know. thanks.
ps. I’ve read the whole thing, not just the title.
As a sole-proprietorship you are opening yourself up to losing everything you own if you’re faced with a lawsuit. When you create an entity that sits in an attorney’s file cabinet, your personal assets are protected (most of the time).
It’s important not to confuse business structure with insurance. If you are sued and at fault, it doesn’t matter what structure you have, you are not magically immune to the damages owed. The best way to protect your assets against a lawsuit is to have professional (for advice, services, etc.), general liability insurance (people injured on sidewalks or other premises and so forth), or product liability insurance.
You should have an entity that protects against personal liability AND insurance for maximum protection. Thanks
It really ends up protecting your butt!
It’s great to bring in that kind of money. However, I think they should be more careful about their legal structure. In response to Dan, being protected under a Corporation doesn’t make you “immune”, but it definitely IS a safer route. The only way they can come after your personal assets is if you sign a Personal Guaranty that states you’re willing to front any costs in the event your company goes bankrupt. I’ve had to do this with my restaurant. The smartest thing any entrepreneur can do is research the pros/cons of various entities. A good example of this can be found on BizFilings:
http://www.bizfilings.com/comparison.aspx
-Frank
That is just downright scary. Protecting your income and assets by having the correct corporate entities in place should be one of the primary things any businessperson should have in place. If you started small and have grown, then now is the time to consider looking at putting the right structures into place.
Yes, the right structuring can easily help you save so much money.. especially through law suites because when you grow, it’s just inevitable for you to across some.
Fantastic analysis Scott. I recently setup a LLC for my website for many of the reasons you mentioned. Despite the fact that it may be a disadvantage to raising capital down the line, the limited liability, low cost, and ease of formation in the short run more than offset any risk of raising VC down the line. At least in my humble opinion.
Thanks Mike -that’s fine; however, as most experienced lawyers wil advise: if you will be seeking VC funding, corporations are the way to go.
Great article! Very informative. Can foreigners make corporations in the States?
Thanks Fred. Yes, foreigners may incorporate businesses in the States; however, you would want to speak to your tax advisor first. Often it makes more sense to set-up a company in the Cayman Islands or Bermuda.
The Cayman islands work for me. They (and Bermuda) are the new Swiss bankers of the internet world. My oh my, but the times have changed….
lol yes this true, but you got to do what you got to do when it comes down to your money.
Yes, Scott did an amazing job with this article.
why do you have a another writer with you?
I wanted Scott to share this information with you because he’s a professional in this area.
Nice post….. Very inspiring!!!
I agree with Scott Walker’s Conclusion “Picking the right corporate entity is a very important set in the entrepreneurial journey. “
I’m also drew attention to this phrase but I think that the main thing – goals of business and legal support – minor matters
Thanks, but not sure I understand your comment
Thanks – but that was Neil’s conclusion
Very detailed post, thanks!
Still, its definitely not my favourite, as this information is easily available on the net and literally every blog about business has one of these.
Thanks Mike. As Neil advised me, actually it’s difficult to find all this information in one place.
Very Informative post.
I like the LCC and soon going to launch
That”s great! Good luck on getting it all setup!
The most important tool in Hammer. This will let you create floors, walls, ceilings , catwalks almost anything can be made by using simple brushes. But for the more compelx shapes, you’ll need models (I won’t cover placing them in this tutorial, but I hope to in the future).
haha, interesting insight “best real estate”
great advice – thanks
Thanks Scott, great post. One thing that still confuses me is whether its better to create an S-Corp or an LLC when you plan to distribute equity as shares with partners. I’ve heard VC’s say that in the early stages an S-Corp is best but recently a lawyer told me that it makes no difference. Are there pros or cons for the startup in terms of taxes or legal fees that a new business should consider?
Richard:
Most VCs won’t touch an LLC (or other pass-through entity). If you are starting a new entity, and think you will purchase venture financing in the future, then an S-corp is probably a better choice. Corporations are easy to understand, an S-corp has optimal tax treatment, and flipping from an S-corp to a C-corp in connection with a venture financing is extremely easy. Issuing equity to employees is also cleaner and easier with a corporation (versus an LLC). If you are working with a lawyer, it is likely less expensive to form an S-corp and issue equity to employees, as an operating agreement with an LLC can get complex, especially when rank and file employees receive equity compensation. Check out http://www.FilingsMadeEasy.com for some great info.
wow.. thats pretty comprehensive and helpful. Sole proprietorship is useful for people who do not want to go really big.. and in my opinion is good for a start. BTW.. what are US laws individuals doing business in their name and not registering companies.. for say blog owners etc.?
If you’re operating a business other than under your own name, you need to file a fictictious name certificate with your local county or with the state.
THx!) Nice post) so Interesting
normally guest posts do not feature large volumes! It was very interesting to read … these things inspire me
Yeah I know right. I only have so much time in the day and need to go to places where I can get the good info that I need in condensed format and that’s what I get here. But this is a great post. Very very good. Solid info.
Thanks bud. This should be a very quick and easy to access guide for basic info.
Excellent. This conversation comes up regularly in our meetings with entrepreneurs and start ups. Just as important, to clearly understand accounting and tax compliance and to build your accounting system with an expert in YOUR category. (Not just a Friend).
Do that and we should be your next call. naming, branding, launching, marketing – http://mind4marketing.com
I think a couple of key points were missed here. An S-Corp will allow you to avoid a good chunk of self employment tax by paying yourself a reasonable salary and taking the remainder of your profits as a pass through dividend not subject to self employment tax. You can’t do that with an LLC. This move alone can save you thousands of dollars in tax per owner.
Second, although I only know this for California, your first year’s fee is waived for an S Corp, but not an LLC, making that a more expensive choice.
Finally, although you could pay $1-$4K or more to form these entities, you can also do it yourself or with the help of a Nolo book and avoid that cost. Filing to create a new Corp or LLC is literally a few page form and 15 minutes of your time- don’t be fooled into thinking it is way too complicated to do on your own because it isn’t unless you have some very specific special circumstances.
1) Entrepreneurs should discuss tax issues with their tax advisor/accountant.
2) I never heard of a State waiving franchise taxes for an S corp.
3) Very poor advice to “do it yourself” if you’re seeking outside investors. I’ve seen this mistake made over and over again.
1) They should discuss it, but that doesn’t mean what I said isn’t true. I’ve saved myself over $100K since I incorporated using this completely legal and legitimate strategy.
2) Per the California FTB:
For your first taxable year:
• If your corporation incorporates or qualifies to do
business in California on or after January 1, 2000, you are
not subject to the minimum franchise tax. Your
corporation is still liable for a franchise tax on its net
income.
3) If investors come on board, they redo everything anyway, and if they don’t, which is the vast majority of the cases, you’ve spent all that money having a lawyer do something in a more complicated but basically equivalent way for nothing.
I just saw Scott that two of your offices are in CA- how do you not know about the S corp minimum franchise tax exemption? This is pretty important, since most businesses don’t have profits the first year, so they are essentially saving themselves $800 by choosing an S corp over LLC or C corp in addition to other benefits. I would think you would know that.
I didn’t know that either. Interesting fact that is very useful for new businesses.
If you have a good attorney in the first place, it makes things a lot easier when investors come on board.
I’ve been working with entrepreneurs choose the right entity type for years. There is a lot of good information available online as well. I have found Filings Made Easy (www.FilingsMadeEasy.com) to be a great resource for entrepreneurs to form their corporations (including S-corps) or LLCs, especially when budgets are limited and law firm rates are out of reach. Filings Made Easy provides a fully automated online process to easily help with entity formation (and it is affordable!), plus they provide registered agent services across the U.S. I recommend many smaller clients to Filings Made Easy and have only heard great reviews.
There are law firms, like mine, that provide a “Startup Package” that is reasonably priced and have a full set of pre-funding documents (including Founders Stock Purchase Agreements, Invention Assignment Agreements, etc.). As noted above, if you’re serious about getting outside funding, you are making a mistake trying to play lawyer.
I’m currently a sole proprietorship and it seems to suit me very well. I’m going to have to figure out what type of paperwork I’ll need to have and file whenever I hire my first employee.
That’s fine, until you get sued; it’s prudent to protect against personal liability. Thanks
I’m from Ukraine… reply me more detailned please
thx you!
You may want to consult with someone out there since many laws will be different.
Isn’t it that it varies depending on the geographical location? I mean the price tags aren’t the same right?
Yes, varies by location and lawyer(s)
Wow what a post. I reminded me of a course I did in the university. It was Entrepreneurship Management SML 302. This post was like a revision.
wow nice information here Neil, I’ve studied this before in my Entrepreneur subject and this topic is really helpful especially for business minded people.
Wow…. This is so much info… I am trying to pick an Entity for my business next year when my profits are a lot higher.
I do want Venture Capitalist in my near future because I think I have huge potential. This stuff is so confusing and way over my head right now.
I guess I have to do my research.
Thanks,
Brian P
If you’re seeking VC funding, I would suggest a C corporation or S corporation. Thanks
Good article. Those of us who have gone through the process of examining the company structures available know how confusing the process can be. Scott Walker put this information in an easy to understand manner. Good for anyone to review.
Thanks for the post. Choosing which company to set up has been difficult for me in the past. The articles I have read in the past didn’t do as good of a job as explaining the pros and cons.
Neil came-up withe idea and format. I think it worked-out well. Thank you.
Great – glad you enjoyed it
Felt like I am studying my Entrepreneurship book :p
Same here this post just refresh my mine about my Entrepreneur subject. Now I remember all of these
Perfect
Make sure you read it over and over again since it can become critical!
Really great article for someone on the brink of entrepreneurship. Thanks a lot!
Hi guys,
I never realized that there were so many entities. The only one I ever heard of was sole proprietorship. Thanks for sharing.
Kind regards,
Sam
X
I was thrilled to finally read a thorough analysis of just how corporations arrived at the powerful position they occupy today. I knew of corporate personhood, but heard only superficial explanations. Nace logically and comprehensively filled in the who, what, when, and why gaps, providing a powerful tool for those who want to understand our society, consider alternatives or challenge the concept and consequences of corporate personhood.
This is a great post. Big ups to you Neil for getting this man. Neil, what is KISSMetrics registered as? LLC? C Corp?
Thank you. This is absolutely great. I have been thinking of incorporating sometime soon and this just reminded me of how I want to do it. This is really a great post.
I was particularly interested that you mentioned “pillar articles”. This is an expression that I have read in the writing of Yaro Starak. I think that this something we should all pay more attention to … “evergreen” content will always be more likely to attract more traffic.
Exactly, at least you’re staying on track with what you need to do.
In the UK the good thing about moving away from sole trader to Limited Company is to remove the impact of personal liability for company finances.
Protect yourself as much as possible, but not to the extent where your corporate entity is overkill for the task at hand. When you have to pay accountant fees and the like for bigger corporate entities that are actually just ticking over and not making money it could get quite expensive, so just watch out for that.
I’d like to know if I can republish this on my blog with a credit as noted in the author bio above. Not trying to take from Neils blog… but I think my somewhat limited readership would benefit from this information.
Please advise.
I don’t know that there are lots of factors needed. Thanks for sharing this now I know that I must learn this before getting contact with a great deal
I have got demat account on my name.I want beginners’guide with step by step instructions. what is the procedure in layman’s language to go for online trading in indian share market.
I would suggest that you connect with a professional who specifically deals with someone in that particular market.
Thank you, Scott! Great analysis and awesome post. What would you suggest as the easiest for non-USA people that would like to start ecommerce business in USA?
Hi all post of this site is very useful and very impressive all is very nice and telling about Beginner’s Guide to Corporate Entities.
Thanks buddy, hopefully you can take this knowledge and apply it in your business.
Saving money and being more frugal is neither a science nor an art; rather it is somewhere in between and requires your commitment and hard work. Saving money takes time to develop, needs to be learnt, and brings benefits that will endure for the rest of your life.
Begin to save money today. Do not put it off. Saving money is within your control and can bring you huge benefits. You will reap the rewards of saving money for years to come. Whether you save money on travel, save money on insurance, or save money on heating bills, remember every little counts – start today and save money every day.
It’s not a technique more than it is a mindset. If you can just create a habit and live your life as if you’re already that type of person, the process becomes easy.
I have friends that have had to leave off degrees from their CVs to get the jobs they wanted. You might have to advertise yourself leaving out a few of the features if you want a given job, then show your true colors with time.
You definitely have to advertise yourself in some way, shape, or form… no doubt.
One of the most important early decisions an entrepreneur must make in connection with his or her venture is the choice of entity. Below is a discussion of each entity, including a basic description, its advantages and disadvantages, the ideal candidate/business for such entity, the cost to set-up such entity and the most important take-away.
It’s a big and important decision so it’s imperative for you to figure it out in the beginning.
Great resource, I printed this out with cute pdf and have saved it to my external hard drive for reference. I would add only that an LLC provides some level of legitamacy that sole propritorships lack. Not that it is necessarily true, its just more a case of perception over reality from my experience. -David
Well that’s great that you had experience in this and have learned from what you did in the past.
Neil, you should really get a handle on this blog spam. I know large comment counts look good but when there is so much spam it devales all commentors. I would say you have at least 50% link spam here.
I have quality control on the comments so there are many that are removed.
Great post. Very informative. I have been need this info for a while, and it’s just like pulling hair to find out more. It’s so boring to me…but I needed it. Anyhow, you made this topic much more interesting and easy to digest. I liked it. Thank you.
Yeah it’s not the most exciting topic but it’s critical to setting up a successful business.
A valiant effort on a complex subject. Here’s some interesting sites (including mine) you may want to visit to get a flavor of how massive the controversy is over this thing.
Yes, it was definitely written clearly.
Yup I already use this practices. and I’m waiting for your new post
Good for you! There are several more to come, just make sure you subscribe via RSS or email.
I may have a controversial opinion, here, but I believe that when you look into the future and think about the costs associated with converting from one corporate entity to another, you also need to look at your immediate resources, prioritize your energy, and keep the idea of “cost” in context.
There are several different areas you need to look over so I suggest you contact a professional before making any decision.
Great summary. One could spend a month in a college course covering the pros and cons. We chose an LLC.
Bryan
Yes, I don’t think spending that much time is necessary, so hopefully this clears up a lot of questions.
Here’s a question I haven’t seen asked here yet, but I think many readers may be in this situation.
I’ve been doing business as a sole proprietor for about 4-5 years (no investors and not planning on taking investment in this particular biz). I AGREE that incorporating is the way to go and it’s something that I’l be doing in the next month or two. It’s been on my radar for years as I did this biz through college, but now I’m graduated and need to formalize all of this…
But how do I transition to from a sole prop. to corp or LLC liability-wise?
For example,
I have client’s I’ve been working with as a sole prop for 4 years. I’d continue to work with these clients as a corp or LLC after filing. But if (unfortunately) something happens with one of these 4 year clients and they decide to sue, could they pierce my liability corporate umbrella and sue me personally since they worked with me before my corp filing. For the sake of this question, assume that whatever they’d sue for happened *after* my corporate filing.
To be honest I am not 100% sure. I could consider calling a lawyer like Scott and seeing if they could help you out.
Thanks for this post, Scott (and Neil). I think it’s clear what entities to choose if you’re looking for external funding / VC investment, but what if you’re not, and you’re still looking to limit personal liability?
Any corporation helps protect against liability other than a sole proprietorship.
I may have a controversial opinion, here, but I believe that when you look into the future and think about the costs associated with converting from one corporate entity to another, you also need to look at your immediate resources, prioritize your energy, and keep the idea of “cost” in context.
There are a lot of things that come into play when you’re deciding this, that’s why it’s best to speak to a professional like Scott.
then again, I have to disagree! don’t prioritize your energy… that’s just being lazy……
Being lazy is a big killer to anyones success…. you must be aware of it and stop it if you find yourself there.
For me, I think beginners should start on Sole proprietorship. From this, it is easy to manage, inexpensive and will let you learn the ins and outs of business
It depends, for some it maybe the best option, for others it’s not. That’s why you should consult with a professional before you make your decision.
I don’t know that there are lots of factors needed. Thanks for sharing this now I know that I must learn this before getting contact with a great deal
Yes a professional will help guide you into the right direction.
Although money allows you to live a comfortable life, it won’t necessarily make you happy. When I first started making money, I realized that materialistic objects didn’t please me. The only thing that really makes me happy is helping other people.
If you help enough people get what they want, you’ll get anything you want.
Because let’s face it, there is only so much I can do, but if we all push for making the world a better place, it’s more likely to happen.
Exactly…. more people with that kind of mindset will make the world of difference.
I just saw Scott that two of your offices are in CA- how do you not know about the S corp minimum franchise tax exemption? This is pretty important, since most businesses don’t have profits the first year, so they are essentially saving themselves $800 by choosing an S corp over LLC or C corp in addition to other benefits. I would think you would know that.
Good to know. Every penny adds ups.
Would this also be true with a UK equivalent doing business in US?
I would talk to a professional in the area to be certain.
I am running a sole proprietorship firm and I want to expand it. Due to lack of finance I am think thinking of changing it into a partnership firm with my friend who is interested in investing a good amount…don’t know if i am taking the right decision…I am happy with what I am doing….
Well just make sure you talk with a professional before committing to any decision.
Choose very carefully your partner. Like Neil posted some time ago it’s like a marriage. You are bound to life
Interview some people before you finalize your decision.
Great post. This probably will help to those engaged their self in a business that encounters important decision-making. Such basic choices is of big help in this corporate entities. Very informative!
Scott did a great job explaining it didn’t he?
I have had to go threw this myself and I ended up forming an LLC. In the past when I worked as a paralegal I had to set up LLC’c S corps and so on. There are many nightmares and ultimately I would have an attorney help you figure out witch one you will need, or ask your accountant, then have the attorney help you through the process.
Ouch, sounds like a brutal process. Having an attorney is always the best way to go.
It is brutal and I am the one who had to most of the research. I loved working at the law firm but working from home has its benefits. I do however miss the court appointed work I got. “I ain’t got no money for child support cause I nails and hair did” it never got old.
I’m not sure if this is the case in the US but in the UK there are additional expenses differences that affect different business entities.
There are many parts to it which is always why I believe it’s best to hire a professional.
With the advice of a tax professional, I recently started an LLC, even though my business is not big yet. Even though a Sole Prioprietary is the easier way to go, this route seemed better in my expanding business.
Well just make sure you seek an experts opinion before you you firmly decide on what you want to do.
Thanks Neil & Scott. Great concise article that was clearer than anything else I’ve seen online. It’d be great if you could do a follow up article explaining the process of transforming one structure into another structure.
I’m considering doing business consulting (marketing, design, project management) and weighing the choices with the different structures. I’m leaning towards sole proprietorship as it’s the simpler & economical option even though it does carry the liability. I’m planning on doing a trial run with a few confirmed clients and if I feel there is an opportunity then I would invest the money to transform from a sole proprietorship into something else. Any insight into that process would be appreciated!
You should set up an LLC because it provides protection and is easy/cheap to setup. Plus it is good for taxes.
Another thing to keep in mind, is you should choose your corporate entity early on in your startup’s life cycle. It’s much more difficult to change later.
Exactly… the sooner you figure out the direction, the less you’ll need to worry in the future.
Links are important, but how do you get them, and how to you ensure that they stick around? There are a variety of methods to gaining links; from blogging and building social profiles, to renting links and mass submitting your site to directories.
Yes, but the best way to do it is to provide solid quality content.
amazing article! But things in India are little different. Wish I could find a similar article suitable for india.
Well you should probably speak to a specialist out there to guide you in the right direction.
thanks for this wanderful post, now i see why so many people i have seen had bad experiences, its a hard thing to decide
It’s really tough… That’s why I always recommend you getting a professional to help you out.
thanks for this wanderful post, now i see why so many people i have seen had bad experiences, its a hard thing to decide
It is… and that’s exactly why it’s best for you to hire a professional to take care of it.
This was a very timely post for me as I’m getting ready to switch from a sole proprietor to an LLC for the added protection. While I’m certainly not making the kind of money that Neil talked about above, I’d rather get started with the protection now.
I definitely needed to read this. Thank you, it’s really helpful that we have people like these to tell us such things.
I’m glad you found it useful and if hopefully helps.
Wow, my head’s spinning. Going to need to print this out for future reference.
My small freelance business has begun to take off and I’ve been thinking of doing some kind of incorporation so I can work correctly with the taxes.
I know theres a certain “leeway” before taxes are due, I just want to make sure I’m all set before I accidentally cross that and have people knocking on my door haha.
It’s always best to seek an expert like Scott to guide you through the process. This is definitely an area you don’t want to be messing around in.
every partner in a general partnership assumes unlimited liability for the partnership’s debts and liabilities, including any tortious acts committed by a co-partner during the ordinary course of partnership business….
yes, very true, that’s why it’s important to choose partners carefully.
this is very handy post…really helpful for a newbie like me who is taking IM seriously..
Yes, this definitely is the perfect information for a newbie.
You just never know how big your endeavour might get or not, and if you’re starting with $50 seed capital you can hardly afford to register much at all!
$50 really won’t get you too far, but it is still possible. You just need to work 100X harder.
If you would ask me, I would rather chose the sole proprietorship.
Whatever the profits you’ve invested, and problems, you are the only one who can face it.. not involving with the other people.
Everyone is different so it is best to consult a specialist first.
What would be most suitable for a single internet marketeer who wants to keep his business as a separate entity in order not to get into any kind of trouble personally in case some big bully decides to sue you?
If you feel that you are in trouble maybe you should look for a partner that can get you out of it, but be careful who you choose.
Yea man it is hard to trust people nowadays… Everyone is so greedy and they do not want to work…. call all the shots…. and do nothing. I guess that is my experience.
Maybe it is a good idea to see what kind of personality you get a long with and search for someone like that!
It’s your best bet to work with a professional to point you in the right direction.
You need to interview a few people before you make the decision.
You need to talk to a professional like Scott to get the proper advice. I suggest you send him a message.
While starting the new business, i think registered as a sole proprietor may easy for starting new business. every choices has their own advantage and disadvantage but important is which more suitable for us.
When you start a business it’s easier to start it alone but on the somewhere on the road you will certainly be in a situation when you need some help in order to improve your business.
There will definitely come a time in anyone’s business where this information becomes vital to your success…
It’s best to talk to a professional like Scott to be absolutely certain.
That’s true I will consult him.
That’ll be your best bet.
A lot of good information here and I like how you’ve presented it, simple and easy to understand!
Scott has done a great job at explaining it.
Really, it is a very useful post, I see many business entities opt LLC and now i actually understand the reason behind it.
Yeah I agree, it’s useful. Always consult with your professional before doing anything.
While starting the new business, i think registered as a sole proprietor may easy for starting new business. every choices has their own advantage and disadvantage but important is which more suitable for us.
then again, I have to disagree! don’t prioritize your energy… that’s just being lazy……..
What do you mean by prioritizing your energy.
Hello, Im looking to start a small web site, Im not looking for outside capital and will be the only partner, I will be selling a product that is handmade and really has low liability (jewelry). I spoke with a lawyer and he suggest a S corporation but the fees are high, if I start with a DBA until I have enought capital to incorporate will it be a crazy idea? how can I protect myself in the mean while? Thank you for your help.
It’s tough. I don’t know how you can protect yourself without having a corporation. For now, I guess you’ll have to roll the dice and see what happens.
Complete is a way to protect yourself if a company fails effort. Enterprises are the oldest form of business entity, which means that the laws surrounding them are well established. In the eyes of the law, an undertaking of a corporation. The result is something known as a shield against liability company. When a company is prosecuted for his activities, Applicant is limited to turn against it.
Thanks for sharing that…. I would still consult with a lawyer before anything though.
Really, it is a very useful post, I see many business entities opt LLC and now i actually understand the reason behind it.
)
Glad to know this was of use to you
This is a very helpful post about something I’ve had a lot of questions about. Having never started a corporation, I’ve also wondered what the nuances were with starting one. This post is a great starting point for anyone that needs to incorporate.
Thanks, Scott!
Either get in contact or find someone local to get your questions resolved.
Dear Neil,I’m new at this, my situation is this; I have a full time job with a company, collect a paycheck, but eventually want to invest in real estate. What I want is a tax shelter through a corporation if thats possible. And if so which corp. would you recommend?
Thanks Fedo
I can’t give you legal advice, so I suggest you consult with a tax consultant or lawyer.
Hi Everyone, Im a little confused on all this, I starting a business from home, and im not sure which one to go with, the business is basically customer service for well known companies, which one would you suggest I go with or do you have any recommendation and advice for me?
Thank you in advance!
It depends what you’re looking to do. Call your local lawyer or perhaps talk to legalzoom.com
Neil are you looking to own a corporation one day? What type of corporation are you looking to open up?
I have a few… it kind of varies as to what type though.
Hello Neil ,
Are these tips really works ?
Definitely, give them a try.
Nice stuff.This is my first time i visit here. I found so many interesting in your blog especially its discussion.Keep your blog updating,good luck…
Thanks, I most definitely will!