As you prepare to launch a small business, it’s important to consider incorporating as a business structure.
What does it mean to incorporate? Incorporation is defined as the process of creating a corporate business structure. This structure, in turn, allows the business to act as a separate legal entity from its owner. The entity formation you choose to incorporate as impacts every aspect of your small business; from personal liabilities the company faces to how much you pay in taxes.
Not sure where to begin? Consider incorporating as one of the following popular entity formations.
- Sole Proprietorship
- Limited Liability Company (LLC)
- General Partnership
- Nonprofit Corporation
Most startups begin as a sole proprietorship. It has even been nicknamed as a “default” entity formation.
Sole proprietorships enable the owner of the business to have full control of the company. They may act as the boss and take responsibility for everything that occurs within the business. However, it can sometimes be difficult to manage running a business in this fashion. What if a customer accidentally injures themselves at your storefront? Or the company accrues too much debt and is unable to pay it off? A sole proprietor would be held fully responsible for these liabilities.
Despite the relative ease that comes with forming a sole proprietorship, it may be beneficial to consider incorporating under an entity that provides limited liability protection. These entities, including limited liability companies (LLCs), not only provide entrepreneurs with limited liability protection to protect their personal assets. They also provide tax benefits, which can create even more peace of mind for small business owners.
Limited Liability Company (LLC)
A limited liability company (LLC) is a popular entity formation with small business owners. Many entrepreneurs incorporate as an LLC for a few reasons.
- Flexibility. LLCs have fewer compliance requirements, such as taking annual meetings or minutes that are required by more structured entities.
- Tax benefits. LLCs are taxed as a default pass-through entity. This means that the profits of the business pass through to the owners and allows the company to avoid double taxation.
- Choice of LLC structure. An LLC may be run by one owner, or member, as a single member LLC. It may also choose an LLC structure that best suits its needs, like a member managed LLC if there are multiple members of the LLC or a manager managed LLC with a board of managers that assist with running the LLC.
Remember to draft a written operating agreement if you decide to incorporate as an LLC. This document details the rules and regulations for running and operating the LLC daily.
Corporations are often a good fit for businesses that are quickly expanding. These companies may wish to expand to have a global presence or would like to take their businesses public with an IPO. Forming a corporation also means you have the ability to issue shares of stock to the shareholders, or owners, of the business. Does that sound? like the direction you’d like to take your startup in? Forming a corporation might be your best bet.
However, corporations are a much more structured entity than LLCs. Certain requirements must be met to keep the business in compliance. For example, you must appoint a board of directors and take thorough minutes during meetings. Corporations must also follow a set of corporate bylaws. These are the rules and regulations for how to run the corporation.
Have you thought about going into business with a friend or family member? Consider forming a general partnership.
A general partnership is the most common type of partnership. It allows two or more partners to establish an agreement that allows them to run the company. The partners can equally divide profits, liabilities, and management duties together.
Once you determine you would like to form a general partnership, draft a written partnership agreement. This document, like an LLC operating agreement, will outline the terms and clauses for how the business is run by its partners.
Are you passionate about pursuing a social cause? You may decide to incorporate as a nonprofit corporation. This is an entity that allows a business to provide public benefit. Some examples of causes supported by nonprofit corporations include advancing environmental goals, addressing social issues, doing charitable work, and aiding in disease prevention.
How does a nonprofit corporation differ from a corporation? Most corporations, unless specified otherwise, are founded as for-profit organizations. A nonprofit corporation is founded for a charitable purpose. The revenue earned by a nonprofit will go towards achieving its mission instead of the business owners.
Like other incorporated entities, nonprofit corporations also provide limited liability protection to their officers and directors. A nonprofit corporation must establish its mission and the nonprofit must be organized for an exempt purpose, allowing it to file for tax exempt status.
Which Entity is Best for My Business?
These are just a few business entities that you may decide to incorporate your business as. Every startup is different and has specific needs. If you have questions about whether you should incorporate as one of these entities, reach out to a trusted legal professional. They can provide guidance as to which entity is best for your business and answer any additional questions you may have about the incorporation process.
Deborah Sweeney is the CEO of MyCorporation.com which provides online legal filing services for entrepreneurs and businesses, startup bundles that include corporation and LLC formation, registered agent services, DBAs, and trademark and copyright filing services. You can find MyCorporation on Twitter at @MyCorporation.