5 Things to Consider Before Creating a Business Entity

creating a business entity

A legal entity involves different individuals coming together to run a business. Various aspects affect the operations of a business depending on its type — from taxation, liability for debts, and obligations of the owners.

State laws govern the business formation, meaning the rights and obligations of business owners are set by the state that is its legal home.

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To gain recognition, a business entity needs a separate identity from its owners, especially corporations, partnership businesses, or LLCs. All such companies should be legally registered in their home state. Here, the rights and responsibilities of business owners are governed by the laws of the state in which the company is incorporated.

LLCs are highly popular among businesses since it limits owners’ responsibility. The limited liability company (LLC) is a relatively modern corporate form with several advantages for its owners. Some well-known examples include IBM, Sony, Pepsi-Cola, Nike, Blackberry, eBay, etc.

If you are about to register your own business, here are some key aspects you should never overlook.

#1. Tax Considerations

Tax implications are one of the key things to consider when setting up a new business. Your business may be subject to corporation or sales taxes if you are into selling goods. There are also municipal, national, and individual taxes depending on the size, state, and structure of your business operations. Therefore, it is a good idea to consult professionals like doola to help pick the right state and structure for forming your LLC and minimizing tax liabilities, given how your company’s legal structure decides your business’s tax burden.

Small Business Deals

Sole proprietorships and partnerships are common forms of company organizations where you are treated as the same entity as the business. Therefore, any gains or losses attributable to your ownership stake in the firm are included in your personal income.

For liability and tax reasons, opt for C-corporation as they are treated independently from your income. Meaning; that the business losses or gains can not affect your taxability. The Tax Cuts and Jobs Act (TCJA) set a new, uniform corporate tax rate of 21%. Profits are given to shareholders after paying the taxes.
Each shareholder’s part of such gains is taxed at a personal rate as per “double taxation”—this policy results in two separate tax payments: one by the company and another by the shareholders.

#2. Forms, Filings, and Deadlines

The type of business structure also defines the severity of your involvement in the business. LLC, for instance, would have many periodic filings and deadlines compared to a sole proprietorship.

Starting up would require you to file the paperwork and establish an official entity. The amount of such documentation differs depending on the business structure.

Moreover, you may also need to provide:

  • Operating agreements
  • Intellectual Property agreement, if needed
  • Non-Disclosure Agreements (NDA)
  • Purchase and sale agreements among stockholders
  • Employment agreements

There are different criteria for creating legal paperwork to sell certain items and services. Verify that you have completed all necessary company paperwork depending on your business type, the products and services you sell, the state where your business operates from, etc.

There are plenty of hoops to go through — notifying the IRS whether you are now self-employed, registering for VAT, forming an LLC, and getting the necessary health and safety certifications. You might face a hefty fine if you don’t comply with filing and documentation compliance rules.

#3. Administration and operation

The administrative and operational powers differ across different types of company structures. For instance, a corporate body will have its most important decisions taken by the board of directors.

No matter if a company ventures out as a sole proprietorship, as it grows in terms of profits and capital, it needs to change into an LLC or a type C corporation. In doing so, the decision power is distributed to the board of directors, where every major decision that affects the company should be written down.

A partnership business can have a deed that decides the administration and operations of the company. But, corporations are owned by their shareholders rather than their employees, unlike sole proprietorships, partnerships, and LLCs.

Depending on the company’s structure, shareholders may or may not be eligible for executive positions. Mark Zuckerberg, for instance, has the dual role of corporate executive and shareholder at Facebook, but this is not the case for all Facebook stockholders.

Therefore, it is better to navigate the right path for your business growth, considering the administrative and operational decision-making before choosing a legal identity. For instance, a company’s Articles of Incorporation (AOI) include a list of incorporators and corporate executives (also known as directors) who take up different roles.

#4. Compliance costs

You should be aware that maintaining an active US corporation incurs several bare minimum fees to keep your business functional. It is better to monitor other operational expenses to ensure seamless business operations.
Apart from the general operating cost of your business like payroll, travel, rent, depreciation, etc., below are some key compliance costs you need to consider when starting a new business.

  • Annual Franchise Tax Fees: if you are running a franchise business as an LLC or corporation, the annual franchise tax ranges from $200 to $1000. Here’s how to calculate.
  • Service and attorney fees for incorporation: States charge between $1,000 and $1,200 for companies, $1,500 for S-Corporations, and LLCs between $500 to $900.
  • Accounting and tax preparation costs: Ranges from $100 to $5000 a year$100 to $5000 a year. The fine for not filing the tax is $10,000 minimum.
  • Other expenses include operating agreements (as mentioned before), startup insurance, industry-specific licensing like restaurant business needed Food Shop License, etc.

For more, read this post on how much it costs to incorporate in each state.

#5. Consider fundraising and future aspects

Consider exploring possibilities like a small business loan or a crowdfunding campaign for your business entity. The sources from which you can fund your business depend on its type and vision. For instance, registering a sole proprietorship or a partnership business will not let you seek funding from financiers and investors. Instead, you’ll rely on personal funds, a bank loan, credit from friends and family, or occasional grants from the government or non-profits.

Some proprietors can get off the ground without outside funding (also known as “bootstrapping”). But, it also exposes them to greater financial risk.

Otherwise, a corporation or an LLC can benefit from the following fundraising options:

Wrapping up

Considering the above-mentioned factors can help you navigate the right structure to establish your company. Primarily, it is best to consult compliance experts before weighing the pros and cons of different business structures and, vis-à-vis, factors affecting each.

Starting a new company is exhilarating, but like any adventure, it comes with its fair share of considerations to make it work smoothly — both before and after you incorporate a business.

Image: Depositphotos

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Pratik Dholakiya Pratik Dholakiya is the founder of Growfusely, a content marketing agency specializing in content and data-driven SEO. As a passionate SEO and content marketer, he shares his thoughts and knowledge in publications like Search Engine Land, Search Engine Journal, Entrepreneur Magazine, Fast Company, The Next Web, YourStory, and Inc42, to name a few.

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