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LLC’s…S-Corps…Sole Props….Huh?!?

February 3rd, 2010 11 Comments

Confused One of the entrepreneurial questions I’m asked most (some friends were asking me last night which inspired this posting) is in regards to the legalities of forming a business. I’ve formed so many LLC’s and “Incd” (that’s lingo for incorporated) so many companies that it’s no longer a very complicated process for me. In fact, I’ve had to find the easiest and cheapest methods available to form these business entities, and now I’d like to share them with you.

The name of the game is limit your liability. I put that in bold because it’s very important. As an entrepreneur, your going to take risks, a lot of them. Picture a corporation or an LLC as an artificial person that you’ve created. Now all of the business you do, the bank accounts you open, the merchant credit card accounts you start and the lease you sign will all be through this artificial person that you’ve created. If for some reason the business goes belly up or some one decides to sue you for any reason, they can’t go after you personally. They can only go after the LLC or corporation and its assets. So your car, your house, your money outside of the company is safe!

If the business can’t pay the bills, the business goes bankrupt not you, unless you’ve signed personal guarantees on anything (which they will most likely make you do when leasing a building, etc).

A sole proprietorship is the exact opposite of what we’ve discussed above. YOU are liable for your business and anything that happens to it. I don’t recommend this as your liability is far too great and you have no artificial person protecting you.

Anyone can start an LLC or corporation, for just about any reason. Whether you have a blog, a restaurant, an Ebay business or you’re a tutor, anyone can run their business through a company. In fact, it is very wise to do so. To provide a good example, I own a restaurant and I have plans on opening many more. What should I do? Open them all under my name or a corporation / LLC. Both would be wrong. I would open each restaurant under a separate corporation or LLC, thereby limiting each restaurant’s liability to themselves. So if one restaurant fails, the others are protected under their own corporations. That’s something they don’t teach you in college! It’s tricky at first, but gets much easier over time. It’s amazing how many novice entrepreneurs (my former self included) have jumped recklessly into ventures and not considered how to limit their risk exposure. It’s a crucial element of the game!

Now that you know why you need an LLC or corporation…it’s time to learn how…here is a very simple breakdown that will explain EVERYTHING you need to know:

  • Corporation – Planning on going public? Then this might be for you. But if this is for a small business, you’ll probably want to form an “S-corporation.” If you form a regular corporation, you will be taxed on both the corporate earnings as well as your personal earnings, which means you’ll be double taxed. That’s no good! An S-Corporation stops that from happening. So you’ll most likely want to form an S-Corp. Drawbacks to forming a corporation are paperwork, record keeping requirements which very state to state and a large lack of flexibility. The main benefit from using an S-Corp is employment tax savings. So only the salary you collect can be taxed, not the profits you collect depending on the amount of shares you own.
  • LLC (Limited Liability Company) – This is what I usually recommend to anyone who wants to start their own business. For all intensive purposes, an LLC is treated just like a corporation, BUT there is very little paperwork, almost no record keeping requirements, complete flexibility in ownership (have as many partners as you’d like), you can distribute the profits however you like and you are still protected by that “artificial person.”
  • Sole Proprietorship – Don’t do it…

So odds are you going to want to start an LLC. Don’t go to a lawyer or accountant to do that! They’ll overcharge you for a service that a monkey can now do (I’m going to catch heat for that one)! There are plenty of online services that you can set this stuff up on. I use Bizfilings.com, they are very reliable and very fast. With a few clicks of the mouse and $150, you’ll have your very own corporation or LLC. A lawyer would charge you $2000. Thank me later….

On a final note, you can form your new LLC or S-Corp in any state you like, but I recommend forming it in the state you’ll be doing business in. Delaware and Nevada are both great places to form these types of entities because of their corporate laws and lack of taxes, while California is probably the most unfavorable place due to their minimum tax of $800 (you have to an annual $800 no matter what, unlike most other states) and their higher taxes. It all really depends on the business. Example: I own a restaurant in California…I formed that LLC in California. The various internet companies I own are mostly run through LLC’s in Nevada and Delaware because they’re based on the internet, not an actual physical location. So why not benefit from less taxes and better laws.

So that covers it all…now go start your company and get the ball rolling!

  • Vocabulary Mary!

    It is “for all intents and purposes” NOT “for all intensive purposes”

    • I didn’t write the post, but I did edit it…..

  • Brooke

    While your advice on starting a company online is helpful, you are forgetting that many lawyers/paralegals/law firms do all of the ancillary work after you simply “form” the company. There are many, many documents that you need to create, such as bylaws or an operating agreement, memoranda naming directors, officers, etc. THESE are the documents that will protect your company should you ever run into legal issues. A simple formation document will not. Also, it is very important to find out about licensing your company. Often, the state or city will require a business license – even if you are just working from home. Failure to obtain this can result in major fines and fees. And I’m not “giving you heat” – simply pointing out that while our fees can be exorbitant, we are the first people you will call when you run into trouble for not having the proper work done in the first place.

    • Great points Brooke. I wrote this article for those that needed simple advice on how to form their own LLC or corporation. I’ve been approached by numerous people asking how they can protect themselves if they wish to start their own small business, and I stress small. Most of the people I have talked to or have contacted me don’t have sufficient capital to pay a lawyer for this service.

      Using an online service is cheaper, BUT it does require more work on their part. Those willing to work a little harder and learn a little more should have no problem drafting up their own operating agreement and relevant corporate documents.

      That’s one of the main reasons I almost always suggest forming an LLC over a regular corporation, less paper work.

      But trust me, in no way do I think or suggest that you guys can be replaced. I’ve got my attorneys on speed dial! :)

      Thanks!
      Mike

  • Vocabulary Mary!

    Then you might consider hiring a real editor.

  • bob Baer

    MIKE

    Great advice….. Very intensive information for all purposes. Just a comment from a guy next store. keep em coming!

  • Kristin

    Another note from a corporate lawyer: yes, we do charge lots of money, but you get what you pay for. In addition to Brooke’s point above, here are a few more to consider. An LLC or corporation formed online can be just fine if you are working by yourself and not planning to issue equity to anyone other than yourself. However, if you are hoping to one day take outside investments (like venture capital) then you should absolutely use an attorney to make sure a) all the intellectual property is properly assigned to your business and b) the company’s capitalization is properly taken care of. I can’t tell you how many companies I’ve had to clean up a year or two after incorporation. Clean up later on = more money spent in the long run.

    • Hey Kristin,

      As I had mentioned to Brooke above, this article was targeted at those hoping to start their own small business on a limited budget. You’re right, acquiring new investors, especially if they’re venture capitalists (sharks!), should always be given the greatest attention, preferably by someone who has studied the law.

      While I do think LLCs offer more simplicity and flexibility as far as issuing equity goes, I would always suggest consulting with an attorney before closing any deal.

      Thanks for the input!
      Mike

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