It is a brand new year, and with this fresh start, many believe that January is an ideal time to start a company. Before you jump into filing the paperwork (by yourself or with the help of an attorney) take a moment to ask yourself these business planning questions. They’ll help guide you to choosing the right corporate entity structure for your new business. Like all Law On Runway posts, this is just general information, not legal advice and we encourage you to speak to an attorney about your business goals.
1.Who are your business partners?
When picking a business entity, you’ll need to know who will be the co-owners as it may determine the type of entity you pick. If it is just you, an LLC or a even a sole proprietorship may be sufficient for you. A sole proprietorship minimizes your tax exposure because you are operating the business as an extension of yourself, so you may not have have to pay additional business taxes separate from income taxes. An LLC for example has a minimum tax requirement in California, which is $800, annually. While it is always tempting to choose the less expensive option in the short term, choosing an LLC over a sole proprietorship may be important though if you have personal assets that you would like to protect from future lawsuits or debts that are incurred by your business activity.
If you are working with others on a business, it is important to incorporate early on in the relationship. Without incorporating, the business becomes a default partnership, and each partner’s personal assets can used to cover any partner’s business decisions that cause the business to gain debts or lawsuit judgments . Having a corporate structure shields the partners personal assets from being used to cover debts of the business, making it a safer choice.
2. Will you be seeking funding?
If you are seeking funding, you will likely want to create a corporate structure where you can offer shares, unless you intend to have only a few investors with long term relationships within the company. An LLC creates pass-through taxation, where owners are taxed for the profits of the company as individual income. Some investors prefer to maintain the ownership of the company in a C-corp or S-corp where the profits are taxed at the corporate level, and the investors only see personal income when they sell their shares or receive dividends from the company. LLC members are also considered self-employed, requiring them to pay into Medicare and Social Security, which also makes this an undesirable choice for many investors who do not plan to be involved in the daily affairs of the company.
The C-Corp and S-Corp structures allow you to offer stocks in exchange for funding, allowing owners to easily come in and out of the company, but each have special requirements for investors or owners. S-Corps have a taxation structures similar to LLC’s where the income is tax as individual income of the owners, and again in California there is the $800 a year minimum in taxes. C-Corps on the other hand are taxed separately, as its own legal personality, and the owners are only responsible for income taxes from the corporate activities when they receive a salary for working at the company, dividends, or a payment from selling shares. C-Corporations and S-Corporations are complex for daily operations and often have higher taxes than individuals, making them a good choice only if you plan to have several people involved in the company’s affairs as investors.
3. How will you pay employees or independent contractors?
Similar to encouraging investors, you may want to offer shares to employees or independent contractors, as incentives for their work, but limiting the amount of decision making they have within the company. For this plan, a C-Corp is usually a popular choice, because S-Corps have that LLC-like personal income taxation structure. Additionally, in California, like many other states, S-Corps have a limitation on the number of owners. In California, an S-Corp can have no more than 100 shareholders. There is no limitation on the number owners of C-Corps, allowing them grow while offering stocks to new employees.
4. Will you have a philanthropic goals?
While we’ve covered the basics, there are other corporate structures to consider. For companies that are devoted to creating a profit and achieving philanthropic goals, several states now offer a B-Corp, or Benefit Corporation. Additionally, California offers the Flexible Purpose Corporation structure. To learn more about these corporate structures, click on their links, which will take you to previous blogs posts detailing their attributes.
Once again, please just use this information as a starting point. Should you become serious about incorporating, speak to both an attorney and a tax professional. To reach Law On The Runway with questions, you can email firstname.lastname@example.org