Weigh Choices When Starting a Business

When first starting a business, or if you are just thinking about starting a business, an important decision will be what type of business entity to select.

For example, should your new business be organized as a corporation, a partnership, or some other entity? Which form of business entity you choose will have important implications.

The most common type of business entity that is established is the corporation. The advantages of incorporation are limited liability, separate and continuing existence apart from its owners, and centralized management. The disadvantages include the need to observe corporate formalities such as stockholders’ and directors’ meetings, increased regulatory requirements, the filing of annual reports and other documents, and possible tax disadvantages.

Limited liability means that liability of stockholders is limited to the consideration that they paid for their stock in the corporation, and corporate assets generally are insulated from claims of creditors of individual stockholders. However, it is important to note that liability may not be limited in situations such as where there is inadequate capitalization, failure to observe corporate formalities or business exigencies such as personal debt guarantee.

Ownership interest is evidenced by stock certificates, held by the stockholders. Policy-making decisions are the responsibility of the Board of Directors (elected by the stockholders). Day-to-day management is the responsibility of the officers of the corporation.

A corporation can gain tax advantages by election to be treated as what is called an S corporation. S corporation status permits a corporation to be treated generally in the same manner as a partnership, namely, tax attributes of income, losses, deductions and credits are passed through to the corporation’s stockholders. Except for tax purposes, the S corporation functions just like a corporation.

One of the main advantages of the S corporation is that it allows individuals to limit their liability for non-tax purposes, without incurring the double taxation to which a regular corporation is subject. The election of the S corporation status provides for a pass-through of losses and profits to the shareholders (similar to partnerships).

Some form of a stockholders’ agreement should be drafted in most cases of incorporation, especially if the corporation has elected to be an S corporation. A stockholders’ agreement can address issues such as death, divorce, insolvency or incapacity of a stockholder, board seats, rights of first refusal, and voting arrangements.

Although there is no minimum level of initial capitalization required to incorporate your business, you should reserve enough money necessary to achieve initial goals.
Apart from incorporation, one might choose to set up a sole proprietorship, general or limited partnership or some other type of limited liability entity.

It is important to seek the advice of an attorney and accountant for detailed consultation on the advantages and disadvantages of each entity for your particular business.