Forming a legal entity is an important step for a new or growing business. Each form of business has its own liability implications, tax consequences, and restrictions on ownership. It’s much easier and far less expensive to do things right at the start than to try to fix a mistake down the road. With all the laws and regulations out there, it’s easy to make a mistake. Help ensure the success of your business; contact Bongiovi Law Firm at (702) 485-1200 or fill out the contact form for information on how we can help you get your business off to the right start.
You’re out there, marketing your company, finding customers, getting paid, and the most official thing you’ve done so far is print business cards. You are a sole proprietor. In fact, most businesses start out as sole proprietorships, but as your business grows, you should consider forming a separate legal entity. The most important reason for doing so is often referred to as the “corporate veil.”
A sole proprietor can be held personally liable for anything associated with the business. This means that anyone suing your company, or you as the owner of the company, can come after your personal assets like your house, your car and your personal bank accounts. In contrast, shareholders, partners, and members of LLCs are generally not personally liable for the obligations of the business. When you form a legal entity, the business then becomes a separate “person.” Therefore, a legal entity provides a shield that protects your personal assets from legal judgments against your company.
The limited liability company, or LLC, is one of the more flexible business forms and is therefore a popular choice for sole proprietors looking to form a legal entity. First, the owners of an LLC are afforded limited liability, like shareholders of a corporation. Second, the business can be taxed as a corporation or as a partnership, giving the members some choice in how the income should be taxed. Finally, an LLC can be member-managed or manager-managed. In member-managed LLCs, each member has the power to bind the company. In manager-managed LLCs, only a manager or authorized officer can bind the company.
In either case, individual members will not be personally liable for the debts, obligations and liabilities of the LLC, provided the LLC is properly formed and operated. This is an important point. Simply forming an LLC doesn’t automatically provide that corporate veil. If you are, for example, paying your mortgage out of the business bank account, or you don’t even have a business bank account, a plaintiff suing your company will argue that you are not treating the business as a separate entity and they should be permitted to pierce the corporate veil and reach your personal assets. It is of utmost importance that you observe the proper operating procedures of any corporation to ensure the corporate veil remains intact.
If you have made the decision to go into business with another person, it is important to realize the ramifications of a partnership. If you have not yet formed a legal entity, you have formed a general partnership. These arrangements are dangerous because each partner can be held personally liable for the debts, obligations and liabilities of the business. In other words, if a partner takes out a loan or commits some error in judgment that leads to a lawsuit, all the partners are responsible and may have to pay for the loan or satisfy a judgment using their personal assets.
In a limited partnership, one person is designated the general partner and the others are limited partners. The general partner is on the hook for the obligations of the business, while the limited partners enjoy the same limited liability as shareholders of a corporation or members of an LLC. In exchange for their limited liability, limited partners may not participate in the management of the company. Limited partnerships are governed by state statutes and are formed by filing with the secretary of state. It is therefore important to have a formal structure and a partnership agreement that addresses these and other issues that often arise and provide an organized and methodical way of dealing with them.
The corporation is often regarded as the traditional form of business entity. Corporations are owned by their shareholders who elect directors to manage the business. Directors then appoint officers to handle the daily operations. Liability for damages or debts is generally limited to the corporation’s assets, protecting shareholders and officers from being held personally liable. Though corporations often choose the subchapter S election, companies looking to go public or raise money from venture capitalists or angel investors gravitate toward the corporation because of investor preferences.
The observation of corporate formalities is even more important in the corporation in order to maintain the protections afforded by this type of entity, such as protecting shareholders from being personally liable for the obligations of the company. Corporate formalities are most important in decision-making by shareholders and directors and keeping corporate and personal assets separated. You may have seen those corporate books – the fancy binders with the heavy corporate seal. Even though many owners set these on the shelf and forget about them, they are intended to be filled regularly with corporate minutes documenting decisions made by shareholders and directors. So, dust off that corporate book, schedule a meeting, and take some minutes!
An S Corporation is simply a corporation that elects to be taxed like a partnership. Unlike with a C Corporation, business income from an S Corporation “passes through” the entity and appears on the business owners’ personal tax returns, sometimes resulting in tax savings. If you are interested in forming an S Corporation, you must file your election with the IRS within the deadline, or risk losing the option. Be sure to consult with a CPA about the best tax form you should elect for your business.
In addition to forming a legal entity at the state level, your business may also be subject to licensing rules at the county and city level. Depending on the location of your business, you might need a city or county business license.
Once you have determined your jurisdiction, you should consult the business license bureau to determine what kind of license you need. Depending on the type of business, you may require a privileged license, which has more stringent standards and often higher fees. If you want to do business in a name other than what is listed with the secretary of state, you must file a Fictitious Firm Name with Clark County.
Businesses operating without the proper licensing can be subject to steep penalties, so be sure your licenses are current.