Formation - Entity Type


0 people found this helpful

1. Do you like the idea of making all the decisions yourself? If the answer is yes, you may want to start a sole proprietorship, which means you are your own business. In this type of business, you are responsible for all the financial issues. This could be ugly when it’s tax season or if there’s a lawsuit against your business. The difficulty with a sole proprietorship is that in the eyes of the law, there is no separation between you and your business. It does not provide any liability protection, so if the business gets sued, your personal assets (house, car, savings account...) are at risk as well. Setting up an entity (like a partnership, LLC or corporation) offers better protection for you. Regardless of the type of company you start, draw a thick bold line between personal and business assets and liabilities (bank accounts, credit cards, vehicles, computers, etc).

2. Do you want to have partners but still be independent? If your answer is yes, you may decide to form a partnership. This requires some sort of formal partnership agreement signed by everyone. It’s a simple business structure that’s easy to operate, and it allows you to raise money by selling partnership interests. But with general partnerships, there are still some measures to take to ensure the line between personal and business finances aren’t blurred. The last thing you want is for your personal finances to be jeopardized because of business issues. This could lead to loss of partners and unforeseen liabilities.

3. Do you prefer a partnership but also want the option of looking for investors to purchase limited interests? If your answer is yes, you’re looking at a limited partnership. Unlike full partners, limited partners are not allowed to manage the day-to-day business in any way. For founders, a limited partnership means the involvement of limited partners is minimal, and you are still entirely in control of your business. However, this would mean that the founders would be "general partners" of the limited partnership, and take on all of the liability of the business. Individuals who are general partners in an LP are personally liable for business debts. Limited partnerships are very intricate and should be designed under the counsel of an attorney. 

4. Do you want a more formalized legal structure that protects you from liability and a structure that separates your personal assets from you company’s debts? Then your best option is to go with a limited liability company. With an LLC, there’s an agreement that governs operations, so it’s somewhat more rigid than an LP.  LLCs don’t need to have advisory boards or hold annual meetings. There’s no limit to the number of members. Ownership can be split into different classes, which gives founders flexibility when it comes to raising equity financing. LLCs make sense if you’re at an early stage where you can attract angel investors who will be motivated by the potential tax losses. As an LLC, you can still elect to be taxed as an S Corp (see below), which may offer some tax advantages to you and the business. Be sure to discuss this option with an accountant, as once you make this election, you cannot "unmake" it very easily. Additionally, if you said "yes" to question number 1 here - that you prefer to make all of the decisions - you can form a single-member LLC which would protect your personal liability and still allow you to run your business with complete control.

5. Do you have your sights set on venture capital? If your answer is yes, a C corp likely makes sense for you. Venture capitalists are comfortable investing in this type of company and often times must do so due to the restrictions of their investors. There are advantages to this entity outside of funding. You have a separation from your personal assets between debts, taxes, and legal structure, with the protection limited liability.

6. Do you want a company that can avoid taxation of corporate income? Then an S corp is for you. This is a good option for you if you are okay with limiting the number of shareholders who need liability protection. An S corp separates personal assets from your company’s debts in the same way as a C corp, and offers certain tax benefits over C corps. S corps aren’t so great if you’re seeking venture capital since you’re limited to one class of stock. Also, every shareholder in an S corp must be a U.S. citizen (born here or naturalized).

Establishing a Nonprofit Organization

If you’re not interested in for-profit work and you want to start an entity that can help people, nonprofits are for you.

There are three categories of nonprofits: unincorporated associations, charitable trusts, and corporations. Unincorporated associations are entities like LLCs, and less government reporting is required both generally but also in a nonprofit structure. But they may run into the issue of not being recognized as tax-exempt or not being able to receive grants from most foundations or corporations. Charitable trusts may be recognized as tax-exempt, but they don’t provide the protection from liability that the directors of not-for-profit corporations enjoy. A nonprofit corporation is the most likely to win major financial support from major donor organizations, which helps ensure its longevity.

Structuring Nonprofit Organizations

For nonprofits, there is no traditional ownership structure, but rather only the concept of "stakeholders." Also, nonprofits follow a somewhat atypical management structure. Most nonprofits have a president, secretary, and treasurer. Some have other positions like vice president or assistant secretary, depending on their individual needs and state law requirements.

Incorporating Nonprofit Organizations

Nonprofits can become a corporation by drafting legal incorporation documents and filing them with a state agency office or state government. The incorporation of a nonprofit legitimizes the organization to the public and potential benefactors. The office of the secretary of state or the attorney general usually handles this process, but in some states approval must first come from a state agency regulating nonprofits. State incorporation of a nonprofit can take a several weeks, depending on the complexity of the review process. The most difficult part of the process is often obtaining non-profit status in the eyes of the IRS, otherwise known as a 501(c)(3) exemption.

Was this information helpful?

0 people found this helpful

Members & Partners That Can Help