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What are the benefits?
Primary Benefit = Limited Liability
The primary reason to incorporate a business is to limit the
personal liability of the owners for the liabilities of the
business.
'Limited Liability' means that the personal assets of the
owners (e.g., their home, personal bank accounts, etc.) cannot
be reached to settle the obligations of the business.
'Personal liability' continues for certain business obligations
such as payment of taxes (e.g., withholding and sales taxes).
Personal liability can also result if the owners 'personally
guarantee' obligations of the business such as notes or leases.
Personal liability can also arise if the formalities of the
corporate entity are not observed by the owners such that
it appears that the corporate entity is merely a 'sham.'
The decision to establish a legal entity for your business
adds cost and complexity. Deciding which type of entity is
right for your business depends on your objectives and plans.
S-Corp, C-Corp or LLC?
S-Corps and LLCs (limited liability companies) have 'flow
through tax treatment' and are attractive for investors or
owners who want to use start-up losses to offset earnings
from other sources. For instance, earnings from your (or
your spouse's) 'day job' can be offset by business start-up
losses.
S-Corps are a good choice for businesses with a limited number
of shareholders and a traditional hierarchical management
model (President, Treasurer). S-Corps also have a solid track
record in the courts and with the IRS.
C-Corps are a good choice if you need capital for your business.
C-Corps are preferred by venture investors because they can
have preferred stock. This means that investors have a 'preferred
position' for dividends, liquidation and merger - with options
to convert to common stock and share in the future growth
of the business. S-Corps are easily converted to C-Corps
by revoking the S-election.
C-Corps are subject to two layers of taxation. This so-called
'double tax' taxes profits at the corporate level and taxes
dividends (which are not deductible to the corporation) at
the shareholder level. The double tax may not be a problem
if: profits are to be 'plowed back' into the business and
not distributed to shareholders; and the exit strategy is
a sale of stock or merger, which is not subject to double
tax. A sale of C-Corp assets is subject to double tax.
LLCs are relatively new in Massachusetts and are increasingly
popular for 'partnership-like' operations, with peer-to-peer
member relations among the owners. Stock option and benefits
plans are more complicated than in traditional corporate entities.
LLCs are a good choice for professional service businesses
and real estate ventures.
Delaware or Massachusetts?
Investors favor incorporating in Delaware because it is considered
corporate friendly. In Delaware, the Secretary of State's
office operates more like a business than a government bureaucracy
and has one of the most advanced and flexible laws for corporations
in the nation.
If you incorporate in Delaware and are doing business in Massachusetts,
you will have to hire a registered agent in Delaware and register
as a foreign corporation in Massachusetts. This means that
you will have to comply with annual filing requirements in
both states.
Hence, if you're really a local business and don't expect
to have investors or expand to other jurisdictions, incorporating
in Massachusetts probably makes more sense.
In conclusion, there are many things to think about in choosing
the form for your business:
1. What is your liability exposure? (Worst case scenario)
2. Can insurance or contracts reduce your exposure?
3. How many people are involved?
4. Do you plan to raise capital?
5. Do you plan to hire employees?
6. Will your company lose money in the early years?
7. Do you plan to sell your business?
This is intended as an overview. The decision as to what's
right for your company is complicated and I recommend getting
legal advice specific to your situation before you make a
decision.
Jean D. Sifleet
Attorney & CPA
P.S. Will you share what you've learned in your business
with other entrepreneurs? I'm compiling stories for my book
and would appreciate your input. Please go to our Web site
at
http://www.smartfast.com/questionnaire if
you would like to participate.
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Jean Sifleet, business attorney, CPA and three-time entrepreneur, is pleased to announce the release of her new book, Advantage “IP”: Profit from Your Great Ideas. Visit the Smartfast Bookstore for details, and to order the book. |
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