Entity Selection: Why and How You Should Incorporate Your Business

In the beginning, there was an idea . . . and then what?

Why incorporate your “business”?

  • If you have more than one economic activity, you want to separate those activities into “buckets” to keep the expenses and assets associated with each economic activity together.
  • Protect your personal assets from any liability that may arise under the economic activity.
  • There is more than one of you involved in the business so you need to agree on how to divide the ownership, responsibilities and profits.
  • You need to raise some money.

When should you incorporate your “business”?

  • When you start to spend money on this separate economic activity such as, setting up a website through buying URLS or engaging professionals and consultants to assist you with design activities and planning.
  • When you need to open a bank account for this economic activity.
  • When you start operating under a name other than your own.

Which “entity” should you choose?

C Corporation

  • Selling a product or good (versus a personal service business)
  • You need to raise money from outside investors
  • You need to retain your profits to grow or expand the business
  • You need to incentivize your workers with equity

S Corporation

  • You can organically grow the business without outside investors
  • You are going to be an owner/operator
  • You have a W-2 workforce
  • You and your family want to operate the business as a family enterprise
  • Individual owners are all working for the business, drawing a salary and participating in the management and operations of the business
  • Once the business is generating income, you can continue to grow and operate the business and still distribute 40% of your cash each year to the shareholders to cover tax obligations

Limited Liability Company

  • It’s just you
  • You can organically grow the business without outside investors
  • You need a complicated capital structure
  • You are not going to be an owner/operator
  • You are okay being self-employed for tax purposes
  • Once the business is generating income, you can continue to grow and operate the business and still distribute at 40% of your cash each year to members to cover tax obligations

In which jurisdiction should you form the entity?

  • If no outside, sophisticated investors, state where HQ is located works fine
  • If outside investors are necessary and those investors are national, consider Delaware

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