Starting Your Business Off Right (Part 2)   Leave a comment

So you have finally have decided to follow-through on your “million dollar” idea and start your own business. Now what? As I discussed in a previous post, your first step should be to hire a lawyer. (Accountants can be really useful, too.) Usually, the first issue your attorney will tackle is entity choice, i.e. what type of company should you—and your business partners, if you have them—organize? Almost always, you will want to choose a form that offers limited liability. Otherwise, all of your personal (non-business) assets, including your house, your car, and your dog, will be within reach of your business creditors.

Determining which type of entity suits your needs best is not as simple as it might sound. Generally, two main concerns affect entity choice—liability for business activities (governed by state law and federal bankruptcy law), and income tax consequences (governed by state and federal law). Today, most states recognize corporations (both for-profit and non-profit), limited liability companies, general partnerships, limited partnerships, and limited liability limited partnerships, with the most common forms for start-up businesses being the business, or profit, corporation and the limited liability company.

Both of these forms, if utilized properly, limit the liability of the business owners to his or her investment in the company. The income tax consequences, however, can vary greatly. A corporation can only be taxed as a corporation (although there are some optional tax treatments for corporations). A limited liability company, however, can choose to be taxed as a corporation, a partnership or, in some cases, may be disregarded for income tax purposes. Further, the limited liability company form offers more flexibility in the management of the business and the allocation of profit and losses to its owners. But how do you know whether you need this flexibility, and what form is right for you?

Having a detailed business plan and clear picture of how you want and expect the business to operate can help your lawyer make the right choice for your business form. The following questions highlight some information your lawyer may find helpful:

• What type of business will you be operating, e.g. retail product sales, business-to-business sales, service-based?
• What type of assets do you anticipate owning and using in the business, e.g. will you carry inventory, own or lease real estate, or need to purchase specialized equipment?
• How will the business initially be funded or “capitalized,” e.g. will you (and your partners) be contributing cash, property, some combination of both, or will you seek out a bank or finance company to obtain a loan?
• Who will have responsibility for day-to-day business operations and decisions? What about major decisions?
• Will the owners be working in the business? If so, in what capacity?
• How will profits and losses be split among the owners? Will it be the same for cash received (or lost) from the daily operations of the business and for extraordinary transactions, such as the sale of the entire business?
• If the business will have more than one owner, should the owners be able to sell or transfer their stock or interest in the business? If so, under what circumstances (e.g. to family members, other owners, upon death or retirement, etc.)?

This list is not exhaustive. Nor is every question on the list relevant in all situations. The list does, however, illustrate some of the considerations involved in choosing the right type of entity for your new business and can be a useful resource as you prepare to meet with your lawyer.

By: Kathleen Hart, an associate in our Corporate Department

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