Frequently Asked Questions about Starting a Business
The following is provided by Reed, Heller & Cannell, LLC for general informational purposes only and may NOT be relied upon as legal advice.
Should I form a legal business entity for my business?
If you operate your business as a sole proprietorship (i.e., you do not form a legal business entity), you are personally liable for the obligations of your business. The cost to form and maintain a legal business entity is relatively low. If you operate your business through a limited liability entity (e.g., LLC or corporation) and observe basic business entity practices and formalities, you will not be personally liable for obligations of the business (subject to certain exceptions).
Should I form an LLC or a corporation for my business?
While most new businesses will be formed as either a limited liability company (LLC) or a corporation, the best entity choice for any particular business depends on a number of factors, including the number of owners and/or investors in the business, the agreed business terms among the owners / investors, the tax preferences of the owners / investors, and the goals of the business. The decision as to what entity is best for your business should be made in consultation with a corporate attorney and a business accountant.
What are the primary benefits of an LLC (as compared to a corporation)?
LLCs are simpler to form and require observance of fewer business formalities to remain in good standing and to preserve limited liability protection. Additionally, LLCs offer a greater degree of flexibility with respect to tax and other issues relating to the rights and obligations of the business owners.
What are the primary benefits of a corporation (as compared to an LLC)?
Corporations require a greater degree of business formalities that must be observed. For businesses with a multitude if investors, this feature of corporations can give minority and/or passive investors an increased sense that there are adequate protections to ensure that the corporation’s management team will operate the business in the best interests of the investors. Additionally, certain types of institutional investors, such as venture capital funds, generally prefer to invest in corporations for a variety of reasons, which makes the corporate structure more appealing for businesses that have the goal of securing venture capital investment in the future.
How do I form an LLC or corporation?
To form an LLC or corporation, you must file a charter document (and pay the associated filing fee) with the secretary of state’s office of the state in which you would like your business entity to be organized. RHC can assist in filing the charter for your business.
Who pays the income taxes on the income of the business?
Most small businesses are taxed as flow-through entities, meaning that the owners—and not the business—pay the taxes on the income of the business. Alternatively, if the business is taxed as a C corporation, then the business is required to pay taxes on the income of the business, and the owners will have tax obligations with respect to any dividends or distributions that they receive. Selecting the appropriate tax classification for your business is a decision that should be made in consultation with a corporate attorney and a business accountant.
Are there different types of flow-through entity classifications?
Yes. An LLC with only one owner may be disregarded for income tax purposes, meaning the LLC itself does not pay income taxes or file an income tax return—the income or loss of the business is reported on the personal tax return of the owner. An LLC with more than one owner may be taxed as a partnership or an S corporation (an LLC with one owner may also elect to be taxed as a partnership or S corporation), each of which are flow-through tax classifications. A corporation may elect to be taxed as an S corporation. While each of these (disregarded entity, partnership and S corporation) is a flow-through classification, there are differences among them in terms of tax and other implications. Therefore, selecting the best flow-through tax classification for your business is a decision that should be made in consultation with a corporate attorney and a business accountant.
What is a limited liability company operating agreement?
A limited liability company operating agreement is a contract that governs the authority, rights and obligations of the owners of an LLC. Among other issues, an operating agreement should address the terms on which business decisions must be made, the rights and obligations of the owners to contribute capital to the business, the rights of the owners to receive distributions out of the profits of the business, the terms (if any) under which an owner may or may be compelled to sell or transfer their ownership interest in the business, and the restrictions (if any) on the owners’ rights to invest or otherwise participate in other businesses.
Does my LLC need a written operating agreement?
While a written operating agreement is not required by law, an LLC that does not have a written operating agreement is subject to the default rules applicable to LLCs under the laws of the state in which the LLC is organized. If the owner(s) of an LLC would like to prescribe any rights or obligations other than those provided under the default rules, they must affirmatively do so in a written operating agreement. Additionally, many banks and other institutions may require an LLC to have a written operating agreement as a condition to doing business with such LLC.
Should I have an attorney prepare the operating agreement for my LLC?
While LLC owners can draft their own operating agreement, there are several advantages to having a corporate attorney draft your operating agreement for you. Among them are the following: (1) Attorneys have expertise in drafting contracts with sufficient detail and specificity to avoid ambiguity and unintended consequences. (2) A good attorney will identify issues and options for their clients’ consideration that the clients may not have otherwise thought about. (3) With respect to an LLC with more than one owner, the process of working with an attorney to prepare the operating agreement helps ensure that the owners discuss and are aligned on important business and legal issues prior to committing to the business venture.
What else do I need for my new business entity?
You will need a federal employer identification number (EIN) for your business entity to open a business bank account and, if applicable, set up payroll and file tax returns. RHC can assist in obtaining an EIN.
If you would like additional information or to speak with an RHC attorney about your business, you can contact us here.