(This post is part of a series on starting a business. This page will continue to add links as we I add more content.)
COVID-19 is hitting businesses hard and wreaking havoc on the economy. As businesses and their employees are enduring mass layoffs, many are uncertain about what the economy’s status will be after this is all over and how long a recession will last. That said, some of the most successful businesses started during or out of a recession. That makes sense as many people see their layoffs as an opportunity to start a new business. Recessions are also a good time for innovation as society has to adapt to new norms.
If you are one of those people, the details and legalities of starting a business may seem daunting. Or you would rather just focus on the business side and let someone else handle the legal details. Regardless, this a primer on the basics of starting a business.
Before You Start: Why Create a Formal Business Entity?
The top reason that you want a corporate entity is to protect yourself from personal liability. The second reason is for tax benefits. Limited Liability Companies (LLCs) and Corporations are not just for big, fancy businesses. They are for everyone (as an aside: don’t they say you should ‘dress’ for the part you want to be?). Instead of being personally liable for your lease, to vendors, or for other expenses and legal liabilities, your corporate entity will be responsible. The corporate entity will protect your personal assets, in most cases. There are a few exceptions and you and your business must still follow ‘corporate formalities’ (outlined below) in order to ensure that benefit stays in tact. Other exceptions include if you are a professional who is being sued for malpractice and the failure to pay employee wages.
Step One: Strategize a Distribution Model For Your Business
Before doing any business, you will want to have a formal corporate entity, preferably opting for a Limited Liability Corporation (LLC) or Corporation. But before doing that, you want to have a grasp on what your business model will be. If you are going to have business partners, are going to engage in profit-sharing, or want to have investors that you want to easily buy out, then the type of business entity will hinge on those factors. If you want to be an LLC, you’ll want to decide if you want to be a member-managed LLC or manager-managed LLC. Additionally, you want to take into account tax considerations (so consult with an accountant) to determine if you should opt to be taxed as a pass-through entity, a C-corporation, or an S-corporation. Again, this will depend on your business model and goals.
Step Two: Formalize Your Legal and Financial Documents
After you’ve decided what type of legal entity you want to use and you chose your tax designation, then you’ll want to actually file those papers with the Secretary of State. The actual filing is fairly simple and can be done online so as long as you have a clear strategy as I’ve outlined in Step One above. Additionally, if you want to be designated as an S-Corp, you’ll have to file your Form 2553 with the IRS no later than two months and 15 days after the beginning of the tax year when you want the S Corp election to take effect.
Step Three: Formalize Your Written Agreements For Your Corporate Entity
Once you’ve completed your filings with the Secretary of State, then you are officially a corporate entity. Now, you will need to make sure you have internal corporate agreements in place. If you opted for a corporation, then you will need corporate bylaws and a shareholder agreement. If you opted for an LLC, then you will need an operating agreement. Even if you are the sole owner of your business, it is still important to have these documents in place so that you do not lose the benefit of corporate protection (known as ‘piercing the corporate veil’). I’ve also had clients who were the sole business owner but other people started to pretend they were part owners of the business and even entered into large corporate contracts without the business owner’s authority. Having your corporate documents in place can help prevent these disputes or other people claiming they are part owners of your business.
I purposely kept the above simple to show that, at its core, starting a business is simple. Stay tuned for more in these series as I will break down the above 3 steps.