Business Entity Essentials Incorporating Your Business In this series, we will go over the reasons why you may want to formally organize your business and discuss the pros and cons of each kind of organization (i.e., LLC, corporation, etc.). For most small businesses, you will want to form either a corporation or a limited liability company. Why incorporate? You usually incorporate to protect your personal assets from any liability the business incurs. A corporation can also sue and be sued because it is considered a separate juridical entity under the law. Also, forming a corporation can allow the owners to take advantage of certain tax and investment strategies. When choosing between a corporation and an LLC, entrepreneurs should consider factors such as the need for investment, desired flexibility in management, tax implications, and the level of formality they are willing to maintain. Each business structure has its own unique benefits and drawbacks, and the best choice depends on the specific goals and circumstances of the business. I have personally formed LLCs and corporations, including Delaware corporations, and can share my own experiences in dealing with these different types of entities. Should you form an LLC or a Corporation? Corporation Attributes Shareholders have limited liability for the corporation’s debts and obligations, like LLC members. Corporations can issue stocks (common or preferred shares) to raise funds, making it easier to attract investors. Corporations continue to exist even if ownership or management changes, providing stability and longevity. Shares in a corporation can be easily transferred or sold, facilitating changes in ownership. C corporations are taxed separately from their owners, potentially leading to tax advantages in certain situations. S corporations allow for pass-through taxation while retaining the benefits of the corporate structure. Corporations, particularly C corporations, are often perceived as more established and credible, which can be advantageous in business dealings. Corporations can offer stock options or other equity-based incentives to employees, which can be attractive in hiring and retaining talent. Disadvantages of forming a corporation C corporations face double taxation: the corporation pays taxes on its profits, and shareholders pay taxes on dividends. Corporations require adherence to strict formalities, such as holding annual meetings, maintaining detailed records, and following complex rules and regulations. The cost of forming and maintaining a corporation is generally higher than for an LLC. This includes administrative, legal, and tax preparation fees. Corporations have a fixed management structure with directors, officers, and shareholders, which can be less flexible than the management structure of an LLC. Corporations, especially public ones, are subject to more regulatory scrutiny and disclosure requirements than LLCs. Corporations have less flexibility in how they are taxed compared to LLCs. While S corporations offer pass-through taxation, they come with restrictions on the number and type of shareholders. S corporations have restrictions on the number and type of shareholders (cannot exceed 100 shareholders and must be U.S. citizens/residents). Comparing Corporations with LLCs LLCs have more tax options and are not subject to double taxation. LLCs are easier to form and operate with fewer formalities and a more flexible management structure. LLCs may face challenges in raising capital due to the inability to issue stock and less appeal to certain types of investors. There are pros and cons of each, and tax consequences of each so you will want to consider how each is treated by your state and by the IRS so you can make a wise decision on how to organize your business. Forming Your Corporation Like the Articles of Organization for an LLC, but often require more detailed information, such as the number of authorized shares, the par value of the shares, and information about the initial directors. A shareholders’ agreement is a contract between the shareholders of a company. It outlines the rights, responsibilities, and obligations of the shareholders and governs the relationship between them. The agreement typically covers issues such as: Ownership and Share Transfer: It specifies the number of shares each shareholder owns and outlines the process for transferring shares. Management and Decision Making: It defines how the company will be managed and how major decisions will be made. It may include provisions regarding board of directors, voting rights, and decision-making processes. Rights and Obligations: It outlines the rights and obligations of the shareholders, including dividend entitlements, participation in management, and restrictions on competition. Dispute Resolution: It sets out procedures for resolving disputes between shareholders, which may include mediation, arbitration, or other methods. Confidentiality and Non-Compete: It may include provisions to protect the company’s confidential information and restrict shareholders from competing with the company. Exit Strategy: It may outline procedures for the sale or transfer of shares, including buy-sell provisions, drag-along rights, and tag-along rights. Miscellaneous: It may also include other provisions related to the operation and management of the company, such as insurance, indemnification, and amendment procedures. Shareholders’ agreements are important for privately-held companies as they help prevent misunderstandings and disputes among shareholders and provide a framework for the efficient management and operation of the company. Does my company need a shareholder’s agreement? Whether your company needs a shareholders’ agreement depends on several factors, including the size of your company, the number of shareholders, and the nature of your business. Here are some situations where having a shareholders’ agreement may be beneficial: Multiple Shareholders: If your company has more than one shareholder, a shareholders’ agreement can help clarify the rights and obligations of each shareholder and establish a framework for decision-making. Control and Management: If you want to specify how the company will be managed and how major decisions will be made, a shareholders’ agreement can provide clarity on these issues. Exit Strategy: If you want to establish a mechanism for shareholders to exit the company, such as buy-sell provisions or drag-along rights, a shareholders’ agreement can help facilitate this process. Dispute Resolution: If you want to establish procedures for resolving disputes among shareholders, a shareholders’ agreement can provide a mechanism for mediation, arbitration, or other methods of dispute resolution. Confidentiality
