Considered venturing into a new startup but don’t know where to begin?
The first and most important step is to determine which legal structure is suitable for your business needs. A startup’s business plan may change over time, and an owner should be prepared for all possible risks and liabilities the business may incur going forward.
A business’ liability is the most important factor to take into consideration when selecting a proper legal structure. Depending on the type of business, one may be prone to take on more risk, therefore structuring the business as a corporation would be ideal.
Incorporating a business limits the liability of the owner by risking only their initial investment rather than their personal assets. However, in order to take advantage of the limited liability benefit, a business owner must make sure they keep personal assets separate from company assets, also known as avoiding the commingling of assets. Many new business owners do not realize the importance of this and can potentially lose their liability protection.
Another caveat to take in mind when selecting a startup’s legal structure is whether one would require investor’s support or rely solely on the initial business investment. A corporation is able to issue shares of stock which can be extremely useful if a startup would like to bring on new investors.
If a startup is only interested in getting the business going with little to no share of equity then a simpler business entity such as a partnership or sole proprietorship would suffice. A limited partnership may be an even better legal structure, as it calls for a partnership composed of both a general and limited partner where the limited partner is solely acting as an investor and the general partner manages the day to day operations of the business.
However, while the limited partner will have limited liability for any debts incurred by the business, the general partner still holds unlimited liability and is taking a huge risk for the business. The limited partner can still lose his/ her liability if he/she becomes involved in any of the business operations.
While forming a new startup as a sole proprietorship can be as simple as setting up shop, forming a startup as a corporation or a LLC requires adherence to many specific rules and regulations. A corporation requires the filing of the articles of incorporation to the secretary of state before becoming incorporated. Corporations need to conduct annual meetings of the board of directors to take vote and discuss pertinent business decisions. Annual reports must also be filed in a timely fashion along with up-to-date record-keeping.
Tax liability is another factor a business owner needs to be aware of for their startup business. Depending on the entity, there are various methods to lower a business’ tax liability and provide a startup with a much needed expense relief. A corporation is subject to double taxation, meaning that tax would be imposed both on the business income as well as the take-home income of the owners. In a sole proprietorship and partnership all income, profits, and losses are reported on the individual owner’s tax returns and the tax liability is imposed only once rather than twice.
For entrepreneurs, C-Corporation is the most popular choice among startups. So which structure is best for your startup? While there is no definitive answer, a business lawyer may certainly help answer that question.
By establishing the correct business entity, you may be able to protect yourself from liability or debt. With the help of a knowledgeable business attorney a startup can choose a legal structure that combines the limited liability structure of a corporation along with the tax benefits of a partnership. Making an educated decision regarding the entity a startup will form under can provide exceptional results, and provide a business owner with the assurance that their startup will succeed in the future.
Mollaei Law specializes in Business Law. We cater legal services to new and existing businesses, entrepreneurs, and artists to further their career. We help businesses and entrepreneurs by tailoring legal documents for your business, assisting transactions, drafting and reviewing contracts and agreements, negotiating, business planning, setting up businesses, and helping with any of your business transactional forms.
For more information, visit www.mollaeilaw.com or give us a call at (818) 925-0002.
This guest post is written by Eman Zokaeim. Eman is an aspiring law student with a background in Finance and Real Estate. Currently attending CSUN, he plans to attend law school shortly after receiving his bachelor's degree.