Forming a Business Entity - Considerations
What are the considerations when forming a business entity?
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Table of ContentsForming a Business EntityChoosing the Correct Business EntityForming the Business EntityWhere to File & Doing Business in Multiple StatesAcademic Research
Forming a Business Entity
Undertaking the mechanical steps to form a business entity is quite simple. In fact, the process can be completed in a matter of minutes through most State Secretaries of States websites.
Commercial services, such as LegalZoom and RocketLawyer, charge fees to assist with this very simple process.
Forming a business entity, however, is more than simply undertaking these mechanical steps. Generally, it entails making a well-informed decision when selecting the type of business entity and then structuring the ownership and control provisions to reflect the understandings of the parties.
This process is why it is valuable to consult with or hire an attorney when undertaking this process.
Choosing the Correct Business Entity
In our Legal Resources Library, we discuss the various considerations for choosing a business entity. In summary, these considerations are:
- Creation and Maintenance Requirements of the Entity
- Continuity and Fiduciary Duties within the Entity
- Control Provisions for Owners
- Ownership and Compensation Structure
- Limited Personal Liability and Risk Planning
- Business Funding Considerations (Debt, Equity, Property Transfers)
- Taxation (Salary, Profits, Self-Employment Tax, Gains on Asset Transactions)
These considerations, particularly the ownership structure and tax consequences of a particular business entity, can be quite complicated. In this regard, hiring an accountant and attorney who are specialized in small business taxation issues for new companies is invaluable.
Forming the Business Entity
The most common forms of business entity are as follows:
- Sole Proprietorship
- General Partnership
- Limited Partnership
- Limited Liability Partnership
- Limited Liability Company
- Corporation with S - Election (S-Corp)
- Corporation with C - Election (C-Corp)
The sole proprietorship and partnership do not require formal filing with the Secretary of State. These entities arise by default. That is, they arise by simply carrying on a business activity for an intended profit. While the sole proprietorship involves a sole business owner, the partnership regards the association of two or more individuals. The other types of business entity require a formal filing with the secretary of States Office. All Secretary of States websites allow for the filing of entity registration documents via the website. The information required to file a business entity is as follows:
- Business Name
- Business Purpose (often not required)
- Place of Business (Your headquarters where records are maintained)
- Registered Agent (Individual and address responsible for receiving correspondences)
- Business Organizer (Individual filing the registration statement)
- Filing Fee (Anywhere from $50 - $500, depending upon the state, paid annually. )
As shown above, the process of filing the registration is simple. The difficult portion is to construct ownership and control documents for the business entity (e.g., partnership agreements, operating agreements, bylaws, shareholder agreements). These additional documents control the daily operations, structure, and governance of the business. I strongly recommend consulting with an experience attorney in constructing these documents.
Where to File & Doing Business in Multiple States
Most businesses will incorporate in the state where the headquarters is located. That is, small business owners will incorporate in the state where they live and begin carrying on business. Some businesses that intend to grow rapidly and seek outside investors will incorporate in Delaware. You can read more about reasons for incorporating in Delaware in our Legal Resources Library. Incorporating in one state does not prevent a business from carrying on business in another state; however, you must file what is called a foreign company registration in any other states where you carry on business activity. This process is more simple than filing the registration statement. Basically, you provide the same information from your original registration statement to the state where you intend to do business. This can be done through the relevant states Secretary of States website. There is generally an annual filing fee of $50 - $500 for the foreign state. When doing business in multiple states, you will be subject to the state taxation requirements of that state. Basically, you pay the state-required taxes on income earned from business activity carried on in that state. See our Legal Resources text for more information on tax liabilities for doing business in multiple states.
- Why is studying business entities important?
- Holistic (Detailed) Overview of Setting Up a Business Entity