When doing business, the entity you choose is essential for several reasons. This will affect the structure of your business and your financing options. Most startups like Startup Formation Packages require capital to get off the ground. There are two main types of startup financing: debt and equity.
Entrepreneurs need to incorporate to protect themselves from legal liability
One of the reasons entrepreneurs need to incorporate to protect themselves from legal liability while doing business is to avoid being liable for a third party’s wrongdoing. In addition to the risk of personal harm, entrepreneurs must also protect their intellectual property and avoid infringement of other people’s intellectual property. This means signing non-disclosure agreements and protecting their business secrets.
Even before hiring employees, entrepreneurs need to incorporate their businesses. While partnerships and sole proprietorships don’t offer much protection, a lawsuit against the company could expose your assets. Formalizing your business is the best way to shield your assets from any business liabilities. It also creates a separate “person” from the owners, known as a corporation.
Corporations are more flexible than LLCs
When starting a business, choosing a corporation over an LLC is best. The main difference between the two is that corporations are created by statute. After filing paperwork, the state grants a corporation the authority to operate. Corporation laws have existed for centuries, and each state has different rules and regulations. This can make them cumbersome for small business owners.
Many small business owners prefer to operate their companies as LLCs to avoid the formalities of corporate organizations. Corporations require a board of directors to oversee day-to-day operations. However, they are more flexible when raising money from outside investors. This type of business structure also allows for limited personal liability.
While an LLC can be formed in any state, most people choose to incorporate it in the state where they operate. However, a corporation can be formed in any state, including DC. Therefore, weighing each entity’s advantages and disadvantages before deciding which to choose is essential. In addition, if you want to do business in another state, you will need to register. You’ll have to pay a registration fee as well as annual fees.
LLCs create uncertainty for investors
Starting a business using your own money is simple. But when you bring in investors, the process becomes more complicated. For example, one investor may want to be fully repaid before the other owners do. Or another investor may want to be reimbursed proportionally based on membership interests. These differences in ownership structure create uncertainty for investors when starting a business.
While there are several pros and cons to LLCs, the primary negative side is that investors have much less certainty in this structure. LLCs do not issue stock and cannot set up preferred stock structures, but they can create units and ownership interests that can be sold. Because these structures are unfamiliar to investors, they require more work to understand them and are subject to uncertainty regarding judicial enforcement.
When you create an LLC, you must be sure that everyone involved understands the business structure. The members should sign an operating agreement to define their rights and responsibilities. This document will specify the division of profits and ownership and address the capital structure and buyout provisions. The operating agreement should also state whether the members have any rights to sell the company or transfer their membership interests.
LLCs have flexibility in the way they distribute profits
While corporations distribute profits to shareholders according to the number of shares they own, LLCs have more flexibility in how they distribute gains. For example, an LLC can split profits 50-50 amongst its members or split losses 75-25. This gives business owners greater control over how their earnings are distributed and enable them to receive a fair income distribution.
Another benefit of an LLC is its flexibility in taxation. Like a sole proprietorship or a partnership, LLCs automatically report their business income on the member’s tax returns and pay personal income tax on that income. In addition, LLC members who work in the business are considered self-employed and must pay self-employment taxes.
While the tax benefits of an LLC are undeniable, LLCs also offer several disadvantages. While a limited liability company is considered an efficient option for a small business, some owners may need help. Because of this, it’s recommended to consult an accountant before making a final decision.