It’s an exciting time to start a business. With so many technologies evolving so quickly, there seem to be more and more niches to fill, needs to be met—or met better—yet it’s never been easier to get started. However, just because you’ve started a business doesn’t mean you have to also form a “corporate entity” (such as a corporation or LLC), although it might be a good idea.
This decision is easy to overthink. At the cost of some legal work, filing fees and administrative hassles, forming a corporate entity gives you two major benefits:
1. Any contracts for your business are actually with your corporate entity, not with you (assuming you do it correctly*), so your personal assets are protected if your business finds it cannot fulfill the contract. This is the primary purpose of corporate entities, and why LLCs are called “limited liability companies.”
2. A corporate entity is probably the easiest way to handle outside investment by others in your business.
* There are two common mistakes that will defeat this benefit. First, you can forget to sign the contract as an officer of your corporate entity. If you do that, you might be found to have signed the contract in your personal capacity, making you personally liable for any breach, as recounted in this rather sad tale. Second, you can fail to treat your corporate entity as something separate and apart from you, in which case a court might decide your corporate entity is nothing more than your alter ego. There are sometimes tax and other benefits, but these are the two main benefits, especially if you’re just starting out.
There are costs that come with forming corporate entities, and if there are no major contracts—no long-term leases, for example—and no outside investors, then the expense and bother may not be worth the hassle. At the same time, a single-member LLC really isn’t very difficult or expensive to form, and the peace of mind may well be worth it.
If you do have outside investors, then you enter a thicket of regulations, and you really need to talk to a lawyer experienced in corporate law. Also, if you have one or more partners, you’ll need to plan for how you all will get along, what happens when one of you leaves, and how power and money are distributed. That requires an operating agreement, and they increase the cost noticeably.
This much is certain: when you start a business, especially with others, you want to do so deliberately. There really are few things worse than a messy “corporate divorce” engendered by a poorly drafted operating agreement—or worse, discovering that you’ve been in a legally recognized partnership with—and sharing liability with—people you thought were just your consultants or buddies.
What type of corporate entity will depend on tax consequences, your patience with “corporate formalities,” and whether you already have investors in mind. We discuss the taxonomy of corporate entities here.
One important thing to keep in mind: you can start simple, say with a single-person LLC, and move onto larger and more complex forms fairly easily, just watch out for the tax consequences! You also don’t usually need to form the corporate entity in a particular state (such as Delaware or Wyoming) right away; it usually doesn’t make a big difference for small companies. You can change the state of incorporation later when it starts making a difference.
A final note: the name of your corporate entity doesn’t have to be related to your brands, and being granted a charter by the state doesn’t give you any trademark rights in your corporate name. These are separate concepts.
Rick | Sanders Law brings a diverse set of experiences in drafting a wide variety of business creation documents, giving you, your partners, your investors and your clients peace of mind (and legs to stand on) while bringing your new business to the marketplace. Contact us to start the conversation about your business’ legal document infrastructure.