Incorporating a Business – Picking the Best Form
Limited Liability Company, S Corporation, or Plain Incorporation
Oct 8, 2009
Forming a new business has many challenges. One major decision that has to be made in the early stages of starting a business is deciding whether to incorporate the business, where it should be formed, and filing the appropriate paperwork.
Traditional Jurisdiction of Business Formation
Most major corporations across the country are incorporated as Delaware corporations. This practice has its roots in the fact that Delaware has very corporation friendly rules for incorporating and conducting business as a Delaware corporation. Also, Delaware courts have much more experience in litigating corporate disputes and very well-developed laws regarding transactions between corporate entities. This makes it easier to plan for potential problems in a business.
Also, when it comes to businesses dealing with each other, it helps if all businesses are adhering to a similar body of law. Essentially, Delaware law serves as an "additional language" for attorneys who might know the law in their own jurisdiction and Delaware law but who are not likely to know the law of other jurisdictions.
There are also more practical reasons such as cost and lax rules regarding incorporation, such as no need for multiple individuals to serve as officers of the corporation and no residency requirement. It should be noted that even if a business intends to form a corporation or a limited liability company in Delaware, corporate officers (or their attorneys) should be informed about the local rules of the company's resident jurisdiction. These rules may still govern the behavior of the company inside the state where it resides, and there may be additional filings required inside that jurisdiction.
Choosing a Corporate form: LLC, S Corporation, Corporation, LLP, LP, Partnership, or Sole Practitioner
With so many corporate forms to choose from, knowing a bit about what the business will be run like will help a new business owner decide how to structure his or her entity. Some of the primary concerns in making the decision are whether the business will assume a lot of liabilities or whether the person starting the business has a lot of assets to shield from potential creditors of the business, how many persons are going to manage the company, and whether the business needs to be readily transferable.
Incorporate to Lower Financial and Legal Liability
Liability is one of the main reasons why business owners incorporate. Forming a corporation, a limited liability company, or a limited or limited liability partnership can shield the business owners from personal liability in the event of a lawsuit or massive debt by the business. Although liability is a very good reason to incorporate, if the business is extremely small, it does not have many assets (such as heavy equipment or technology licenses), or it is based upon personal services that can be insured against with a liability insurance policy, it may be overkill to incorporate.
Tax Advantages of Incorporation
Another consideration when deciding to incorporate is how the business will be structured for tax purposes. A regular corporation will pay corporate taxes, and then the shareholders, when they take dividends from the corporation, will be taxed on that income as well. This is called double taxation. For most small business, double taxation should be avoided. It is easy to do this by choosing a modified corporate form or a non-corporation form. Forms that allow pass-through taxation of business proceeds are limited liability companies, s corporations, partnerships, limited liability partnerships, and sole proprietors.
Corporate Management & Stock Ownership Transferability
One final consideration in choosing one business form over another has to do with how the business will be managed and whether the officers or shareholders will want to be able to transfer the shares. The true advantage to a full corporate structure is that shares can easily be transferred or sold from one individual or business to another. Additionally, a corporation allows for the appointment of officers which are separate from shareholders. The managers do not have to own the company. In other forms, such as general partnerships, the partners have to run the business.
Limited liability companies are a hybrid of corporations and partnership. The benefit is that the individuals setting up the LLC get to choose whether to be managed by members or by managers. This means that they do not have to run the company to own it. However, transferability is more like a partnership. Members can transfer their rights to receive funds from the LLC, but they cannot transfer management rights.
These are some of the considerations that have to be taken into account when deciding what form a business should take. Each business form has different filing requirements that are too exhaustive to list here, and the requirements vary by jurisdiction.
This article does not constitute legal advice. It is a basic overview of general considerations that new business owners should make when trying to decide what type of corporate format to adopt. If unsure about which corporate form to adopt, please seek the advice of a licensed corporate attorney in the jurisdiction where the business resides before filing the appropriate documents in a particular jurisdiction. For an analysis of the various tax advantages and disadvantages of certain business forms, consult a tax attorney.
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