Choice of Business Entity for Entrepreneurs
For every entrepreneur a new business is an important investment, it will hopefully provide for your livelihood and support your family. And if you are fortunate, your new business will provide income and security for future generations. The choice of business entity that will protect the product of your hard work, financial and sweat equity investments, your most valuable of creations, is not something to leave to a website.
New Business Entity Consultation – What will you discuss with a business lawyer
As part of our startup business services we will discuss the complexities and expense associated with various state laws, federal tax regulations and other formalities. We will discuss the number and types of business owners and the risks and liabilities each desires to assume in the venture. We will discuss how the business will be funded, how the business will be managed and how the business will be taxed. We will discuss the various assets that might already exist that will be transferred to the new entity, and we will discuss the types of assets that the business might create or accumulate.
Choice of Business Entity is not “one size fits all"
These are some of the considerations that go into the selection of the right business entity structure, the location of the business formation, and the necessary supporting documentation for an adequately configured and legally defensible corporate structure.
Choosing the wrong Business Entity can ruin a business
It is not uncommon for an entrepreneur to form an LLC in their own state through one of the many well-advertised options and sometimes the choice they make are sufficient for their needs and sometimes they are not. Unfortunately, the time that may business owners understand that they have the wrong entity structure is after they have difficulty attracting investors, after they get sued by a customer, vendor or business partner, or after they receive unexpected expenses related to maintaining the structure that they selected.
Best approach to the choice of entity decision
The best approach to the choice of entity decision is to carefully consider these and other issues with your tax advisor, accountant and lawyer.
After you have a clear idea of the purpose of the business, its funding sources, its owners and managers and the type nature and location of its expected assets, your advisors can provide guidance on the optimal entity type. Its clear however, that many businesses start without this type of detailed guidance.
Some problems with choosing the wrong business entity
While it may come as some expense, a business entity can be changed or converted. As a result, all decisions can and often should be revisited because the business entity can and often should change during the life of a business. Some entrepreneurs ask what is the risk of choosing the wrong business entity? Since these scenarios are often fact specific I will offer just a few examples:
- For example, an S-Corp cannot have C Corporations as shareholders. Therefore, if an individual S-Corp shareholder transfers its shares to a creditor in bankruptcy who happens to be a C Corp, the S-Corp would have an invalid shareholder and will lose its S-Corp status. If this happens, the change in taxable status will trigger an unwanted tax on the built-in gain of the corporation.
- A Limited Liability Company is a pass-through entity for tax purposes. In many cases it makes sense for new businesses to be formed as an LLC. One common problem however, is when the LLC generates a taxable profit, which flows through to the individual members to pay on their own individual tax report. If the LLC does not have cash on hand for distribution in order to reimburse members for this expense, individual owners would are personally responsible for paying their share of the LLC tax, whether they ever get a distribution from the business or not.
Bottom Line on Choice of Business Entity
The bottom line on choice of entity is that entrepreneurs should treat their businesses as an asset worth protecting and should seek the guidance from tax, accounting and legal professionals.