Establishing an Entity for Entrepreneurs: What to Consider When Starting Your Business
The first step in setting up a business entity, before registering with the state or building capital, is determining a business structure. The most common structures are sole proprietorships, partnerships, limited limitary companies, and corporations.
Business Structures
Sole Proprietorship
A sole proprietorship gives you complete control of your business. If you do business activities but have not registered as a business, you are assumed to be in a sole proprietorship. Importantly, sole proprietorships are not considered a separate business entity. This means that your business assets and liabilities are not separate from your personal assets and liabilities, and you may be held personally liable for the debts and obligations of the business.
While sole proprietors may get a trade name, they cannot sell stock and, generally, banks are hesitant to lend to sole proprietorships. This may make it hard to raise money.
Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.
Partnership
There are two common kinds of partnerships: limited partnerships and limited liability partnerships.
Limited partnerships have one general partner who makes business decisions and is personally liable for business debts, while all other partners, considered “limited partners” have limited personal liability. Limited liability partnerships give limited personal liability to every owner so all partners are limited. Limited partners are not responsible for the actions of other partners. In addition, profits and losses can get passed through to your personal income without facing corporate taxes.
Partnerships can be a good choice for businesses with multiple owners, professional groups, or groups who want to test their business idea before forming a more formal business.
Limited Liability Company
A limited liability company (“LLC”) lets you take advantage of the benefits of both the corporation and partnership.
LLCs generally protect you from personal liability, so your personal assets — like your vehicle, house, and savings accounts — won’t be at risk if your LLC faces bankruptcy or lawsuits. Like a partnership, profits and losses can get passed through to your personal income without facing corporate taxes.
LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets to protect, and owners who want to pay a lower tax rate than they would with a corporation.
Corporation
Corporations offer the strongest protection to owners from personal liability, but the cost to form a corporation is higher than the other structures. Corporations also require more extensive record-keeping, operational processes, and reporting. There are many different corporate structures.
C-Corporation
The most general corporation is a C Corporation (“C Corp”). A C Corp is a legal entity separate from its owners. C Corps can make a profit, be taxed, and can be held legally liable. Corporations pay income tax on their profits. In some cases, corporate profits are taxed twice, both at the business level and at the shareholder level. Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also help attract employees.
Corporations can be a good choice for medium- or higher-risk businesses, businesses that need to raise money, and businesses that plan to “go public” or eventually be sold.
S-Corporation
An S corporation, sometimes called an S Corp, is a special type of corporation designed to avoid the double taxation drawback of C Corps. However, not all states tax S Corps equally. Some states tax S Corps on profits above a specified limit and other states don’t recognize the S Corp election at all, instead treating the business as a C Corp.
S Corps must file with the IRS to get S Corp status. In addition, there are special limits on S Corps. They can’t have more than 100 shareholders, all of whom must be U.S. citizens. They also still have to follow the strict filing and operational processes of a C Corp.
S Corps can be a good choice for businesses that would otherwise be a C Corp, but meet the criteria to file as an S Corp. To learn more about S Corps, read our blog here.
B-Corporation
A benefit corporation, sometimes called a B Corp, is a for-profit corporation recognized by a majority of U.S. states. B Corps are different from C corps in purpose, accountability, and transparency, but are taxed the same. B Corps are driven by both mission and profit. Some states require B Corps to submit annual benefit reports that demonstrate their contribution to the public good.
There are several third-party B Corp certification services, but they are not required for a company to be legally considered a B Corp in a state where the legal status is available.
Close Corporation
Close corporations resemble B corps with less traditional corporate structure. Close corporations can be run by a small group of shareholders without a board of directors.
Nonprofit Corporation
Nonprofit corporations are organized to do charity, education, religious, literary, or scientific work. Because their work benefits the public, nonprofits can receive tax-exempt status by filing with the IRS. Nonprofit corporations need to follow organizational rules similar to a C Corp, but they also need to follow special rules about what to do with any profits they earn. For example, they can’t distribute profits to members or political campaigns.
Nonprofits are often called 501(c)(3) corporations in reference to the section of the Internal Revenue Code most commonly used to grant tax-exempt status.
Naming Your Entity
Naming the entity is the second most important step in setting up a business entity. It is crucial that the name be unique, distinguishable, and not in use by another entity. You can use the Colorado Secretary of State’s corporate entity database, located here, to search if prospective names are already in use. In addition, google is your friend. Moreover, the name should not be limiting, i.e., it should not prevent your business from expanding into new ventures. You’ll want to choose a business name that reflects your brand identity and that doesn’t clash with the types of goods and services you offer.
Registering Your Entity
You can register your entity with the state by filing online, located here. The specific document you file depends on the business structure, e.g., articles of organization for an LLC or articles of incorporation for a corporation. In addition, you can expect to pay a filing fee.
When filing the articles, you must record specific information such as the business address, business number, and names of your members. Additionally, you’ll need to record a registered agent for the entity. A registered agent receives official papers and legal documents on behalf of your company. The registered agent must be located in the state where you register.
You should also double check to see if your business activities are regulated by the federal government or any local or state governments. If that is the case, you may need to get certain permits or licenses to conduct your business.
Raising Capital for Your Entity
Cash is the lifeblood of business. Investors ask tough questions, so you’ll have to be equipped with all the relevant information you need. Your experience may not be like the hit ABC show Shark Tank, but the negotiations portrayed can give you a great idea of what you need to know to obtain investors. Among the different types of investors out there that you may consider are: founders, family, friends, venture capitalists, angel investors, single family offices, business incubators, investment groups, and crowdfunding pledgers. Some of these investors prefer one business structure over another. In addition, they are largely concerned with getting their money back. It is important to be clear about what rights investors are afforded.
As an alternative route, you can also use credit cards, lines of credit, or bank loans. However, these financing options are more contingent on the condition of your personal finances and assets, versus the value or potential value of your business.
Entity Bank Account
As soon as your business starts accepting or spending money, you should open a business bank account. In fact, it may be better to do so before. Most business bank accounts offer perks that don’t come with a standard personal bank account. Common business accounts include a checking account, savings account, credit card account, and a merchant services account. Merchant services accounts allow you to accept credit and debit card transactions from your customers. You can open a business bank account once you've gotten your federal Employer Identification Number (“EIN”).
Your EIN is your federal tax ID. You need it to pay federal taxes, hire employees, open a bank account, and apply for business licenses and permits. It’s free to apply for an EIN, and you should do it right after you register your business.
Conclusion
Starting up a business is not as simple as starting business activity. There is a lot to consider, and the legal ramifications can be daunting. GLO has extensive experience in business formation and would love to help walk you through forming your business entity. GLO will get to know you, your business, and your needs to determine the best business structure for you. In addition, GLO will ensure you comply with all applicable state and federal laws when setting up your business. If you are interested in establishing a business but are unsure where to begin, fill out an interest form today to see if GLO can help you.
GLO has prepared this blog to provide general information on legal issues that may be of interest. This blog does not provide legal advice for any specific situation and this does not create an attorney-client relationship between any reader and GLO or its attorneys. GLO engages clients only through specific fee arrangements and signed engagement letters. GLO does not guarantee any results.