In the second part of The Complete Guide to Business Formation we will discuss Limited Liability Companies along with Corporations. From there, you will have the opportunity to leave comments about what type of business you want to start and I will gladly help you determine which method of formation works best for you!
By the way, if you missed Part 1, click here.
Let’s start off with a basic understanding of the types of corporations. A corporation is a legal entity that keeps personal assets of the shareholders from the firm’s assets. As you can see, this is a big step in the way of limiting your liability as opposed to sole proprietorships and partnerships.
A Limited Liability Corporation (or Company – the terms can be used interchangeably with this type of formation) is an organization owned by the “members”. With an LLC, the corporation’s assets can be seized; however they have no recourse against the shareholders’ personal assets. The great thing about an LLC is that earnings can be taxed at the personal income tax rates of the members. By the way, my company, Brett Adams Design is an LLC.
A Subchapter-S Corporation provides limited liability for shareholders plus corporate income is taxed like personal income to the shareholders. This is a great choice for a number of business types and may provide positive tax treatment, but does involve additional paperwork compared to an LLC.
Now that we understand the types of corporations, let’s take a look at some reasons why incorporation makes sense for most people:
- You limit your personal liability
- By placing Inc. or LLC. at the end of your business’ name, you clearly upgrade your image
- To have the opportunity to channel some heavy expenses
- It guarantees continuity, even after your death, if set up properly
- You can offer internal financial incentives
At this point, between parts 1 and 2 you should have a basic understanding of the different types of entities. Below, I’ve put together a list showing some of the associated attributes for each entity type including liability, capital sources, firm lifetime, and taxation.
- Proprietorship
- One owner, with a short amount of time to set up and low cost
- Unlimited liability
- Most equity capital will come from the owner
- Life of the business parallels life of the proprietor and transfer of ownership is difficult
- Taxed at one’s personal tax rate
- Partnership
- Two or more owners, with a moderate startup time and cost
- Unlimited liability
- Capital sources include other partners, family, and friends
- Life is determined by the partners and again, transfer of ownership is difficult
- Taxed at partner’s personal tax rate
- Corporation (C)
- One or more owners, with a high cost and time to set up
- Liability is limited to shareholders’ investments
- Capital investments may come from venture investors and common stock shareholders
- Business life is unlimited and ownership transfer is easier
- Corporate taxation; dividends subject to personal tax rates
- Subchapter S Corporation (S)
- Less than 75 owners, with a high cost and time to set up
- Liability is limited to shareholders’ investments
- Venture investors & Subchapter S investors can supply capital
- Unlimited business life and ownership transfer is moderately difficult
- Income flows to shareholders; taxed at personal tax rates
- Limited Liability Company (LLC)
- One or more owners, with a high cost and time to set up
- Liability is limited to members’ investments
- Equity capital sources include venture investors and equity offerings to members
- Business lifetime is set by the members, transfer is difficult
- Income flows to shareholders; taxed at personal tax rates
Again, please feel free to comment with the type of business you are interested in starting and I’d be happy to offer my opinion. Class dismissed.
