Saturday, November 7, 2009

An Entrepreneur's Guide to Incorporating Your Business

One of the most important steps in starting up a business is the incorporation process. Your corporation as an entity receives its legitimacy from the state you incorporate in. The most obvious advantage in forming a corporation is that it shields its owners from personal liability. It guarantees that if something goes wrong in the business, the owners won't be wiped out personally.

There are several options when it comes to incorporating your new business. You will need to know your business objectives in order to determine which one is right for you. Many entrepreneurs rush into this process, incorporate with the least appropriate entity and then regret it later. By reading this guide, you are avoiding this common pitfall.

One reason people do not incorporate is that in order to do so, you must file paperwork with the state. To be an S-Corp, LLC, or a Limited Partnership, you have to file papers. What do you have to do to be a General Partnership? Nothing. All you have to do is pursue a business together. That is the default under the law. If you just start working together to try and create something, you are considered general partners, unless you legally change the status of your business.From a liability standpoint, you are also toast, because you're liable for everything personally. Your personal assets are completely exposed.

Here's the differences between each entity followed by a quick reference table:


C-Corps work for that narrow locus of company that Venture Capitalists are interested in. They're interested in high growth, generating cash, and reinvesting it (not distributing it). They're not interested in dividends. They want a high growth rate. They want to sell out, either through a public offer or through an acquisition transaction, earning a high price. This is how they get there: hustle the cash, keep it, grow fast, and use all the cash. This is why VCs almost exclusively invest in C-Corps. You can actually set up a C-Corp and file a form saying that you want to be taxed as an S-Corp (flow-through entity that is taxed once). Later, when you are ready to raise money or bring in new investors, you can change your election to be a C-Corp. It is very hard to do it the other way around.

Limited Liability Company:

LLCs are remarkably flexible. You can do almost anything with them. You can have multiple classes of stock, and multiple classes of interests. You can have foreign investors. You can have an unlimited number of investors. There's almost nothing that an LLC structure won't accommodate. In an LLC, I can do a 90/10 distribution of dividends, and not be tied to the distribution of ownership. It protects your assets like assets like a corporation without the burden of corporate maintenance. With a LLC, you can elect to be taxed as a corporation, or avoid "double taxation" by choosing to be a "pass-through" entity.


A S-Corp structure is very limiting. There are limitations on the number of shareholders and on who can be a shareholder. You can only have one class of stock (there are minor exceptions to that). The S-Corps are very, very inflexible, but they are really cheap to setup. With increased flexibility comes complexity. That's why LLCs are much more expensive to set up.

We can map this out very simply. If you know you're not going to have multiple classes of investors, you should go S-Corp just to save money.For example, if you have a situation where two brothers or two sisters starting a business, sometimes an S-Corp is the best bet; nevertheless, they are really inflexible.

Ask a tax person who is used accustomed to figuring out the problems with an S-Corp. He or she will tell you that if you think there is any chance that something will change down the road, you should incorporate as an LLC from the start. It's much harder to fix a problem later than it is to plan for different situations in the beginning.

Doing Business As:

DBA, or Fictitious business name as it is also sometimes called, is another type of organizational arrangement. If you are an individual, you want to do business under your own name, and you don't want to incorporate, you could use a DBA. Local jurisdictions have their own requirements of how to start a DBA. It doesn't really get you very much in the way of liability protection, but it can allow your company to do business as a new name, and open bank accounts with that name.

Furthermore, it sometimes happens that a company is incorporated in one state with a certain name. Then they go into a different state, and that name is already taken. They have to do business under a different name in that state. That is where it is more legitimate to use a DBA.

Akash Shah
(aux) Founder/Editor-In-Chief

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