Starting a company is actually simpler than it seems. To start a company:
- choose your business type (such as an LLC, corporation, etc.);
- choose your formation state (which doesn’t have to be where your business is located);
- prepare and file formation documents (Articles of Incorporation or Formation); and
- appoint a registered agent.
When you have done this:
- get an Employer Identification Number (EIN) from the IRS;
- adopt governing documents (Bylaws, Operating Agreement, etc.); and
- if you want them, issue ownership documents (shares of stock or membership interests).
Let’s expand on each of these requirements.
Choose Your Business Type
Most small-business owners choose to establish an LLC (limited liability company), a regular corporation, or an S corporation. If you formed and operate any of these 3 structures correctly, your personal assets will be protected from business debts and creditors. Which structure is best for you to start a company? Well, it depends on your goals for your business.
- Limited Liability Company. An LLC provides a great deal of flexibility with respect to (i) management, and (ii) how profits and losses will be allocated to the members. Plus, states impose fewer reporting and record-keeping requirements. However, it may not be the best choice if you hope to (i) obtain venture capital, (ii) take the company public someday, or (iii) raise money via equity crowdfunding.
- A corporation provides peace-of-mind because there are well-established laws that govern its operation and the duties of directors, officers, and shareholders. It is also the ideal structure for raising equity capital.
The downsides are that (i) states impose more record-keeping requirements, (ii) there is a lack of flexibility in allocating profit/loss to the shareholders, and (iii) a regular corporation reports and pays taxes on its own income, and dividends paid are taxed again when the shareholders report them on their individual returns. Various tax planning strategies can eliminate or greatly reduce the impact of double taxation so that fear should not be a reason to automatically exclude the corporation as a choice for your business.
- S Corporation. The S corporation is a regular corporation (or an LLC) that has made an election with the Internal Revenue Service to be taxed as a pass-through entity. This eliminated any risk of double taxation while permitting income received by an owner to be divided between compensation and dividends. This strategy can reduce the owner’s overall taxes. A corporation that makes an S-corporation election must follow all requirements imposed by the state on corporations; an LLC still follows the state rules for LLCs. However, making an S-corporation election forces the LLC to lose its flexibility in allocating profit and loss independently of ownership percentages. Both corporations and LLCs that operate as an S corporation face restrictions on both the type and the number of shareholders/members that the company can have.
To Start a Company Select Your Formation State
You can form your LLC or corporation in any state that you choose—even if your business does not have an office, and will not operate, in that state. Many publicly-traded companies (and those who aspire to be publicly traded) choose Delaware at their formation state. Delaware is a preferred state because it has business-friendly laws, a highly-respected court system dedicated to hearing business cases, and a state-of-the-art secretary-of-state’s office.
However, smaller businesses and those who anticipate staying closely-held often opt to form in the state where they are located. This is less cumbersome (and costly). A business that forms in a state other than the one where it operates must immediately register with the state where it operates. This process, often called foreign qualification, involves filing documents, paying fees, and appointing a registered agent, which can double the cost and paperwork involved in starting up. Plus, there will be ongoing compliance requirements for both states.
Some businesses select their formation state because they want to operate using a structure that is not available in their home state. For example, not all states permit benefit corporations, series LLCs, or close corporations. If one of those structures makes sense for your business, you will need to incorporate or form your LLC in a state that allows it—and then foreign qualify in the states where you do business.
File Formation Documents and Designate Registered Agent
States vary in the amount of information requested—and corporations generally must provide more than LLCs. To start a company all states require that you state the business name and the business address. The name and address of the initial registered agent must be included.
A registered agent can be an individual or a company approved to offer registered-agent services in that state, but in all cases, the registered agent must have a street address in the state. Many times, a business owner will want to list himself or herself as the initial registered agent. In most cases, it’s wise to resist that temptation. A professional registered agent knows how to process properly mission-critical documents—such as notice of a lawsuit against your company, a garnishment against an employee’s wages, or the state’s annual report. Failing to handle these communications correctly and in a timely manner can have serious repercussions.
Privacy is another concern when an individual serves as a registered agent. Delivery of legal documents often is in-person at the registered agent’s address—which can cause embarrassment if customers or clients are present. Plus, the registered agent’s address is a matter of public record. This leads to unsolicited, bulk mailings. A professional registered agent culls the important documents from the bulk mail, saving you the aggravation of doing so.
Every LLC and corporation must have a federal-tax identification number. It’s called an Employer Identification Number (EIN). LLCs and corporations must have one even if they do not have employees. This number is required to file tax returns, but many banks, lenders, and vendors will ask for your EIN – and refuse to do business with you if you cannot provide it.
Another important post-formation duty is to adopt governing documents for the new entity: Bylaws for a corporation; an operating agreement for an LLC. State law generally requires corporations to adopt by-laws. LLCs are not required to have an operating agreement, but it is a best-business practice to do so. Corporations are also required to hold a first meeting of shareholders, a first meeting of directors, and to issue shares of stock. Again, LLCs are seldom required to follow these formalities. But it is a wise idea to document formally all company decisions and transactions.
If you have any questions about forming your new business entity, call the experienced lawyers at George Law at (248) 470-4300. We stand ready to respond 24/7.