How you set up your Company will influence everything from day-to-day operations, your ability to raise money, your tax burden, the paperwork required, and how much you desire to protect your personal assets. You should pick a structure that will provide a good balance of legal protections and benefits. Choose carefully, as there may be restrictions on converting to a different business structure later that could pose complications.
DBA OR A SOLE PROPRIETORSHIP IS NOT A LEGAL ENTITY
“Doing Business As” is also known as a “DBA” and it is not a separate business entity. DBA’s can be used together with legal entities but registered on its own does not give you any legal protections. Further, Sole Proprietorships are not legal entities either. This means that with a DBA or a sole proprietorship, your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of the business.
LEGAL ENTITIES PROTECT PERSONAL ASSETS
A legal entity is an individual, company, or organization with legal rights and obligations. A legal entity’s primary benefit is protecting your personal assets, like your home, vehicle, and bank accounts, in case your company goes broke or faces a lawsuit. So long as the legal entity is formed correctly and maintained, the owners will not be personally liable for the Company’s debts, obligations, and liabilities. It is essential for any company to respect the difference between its bank accounts, property, equipment, and other assets and personal assets owned by its owners. The owners of a Company may be held personally liable when they treat the assets of the Company as their own and add or withdraw capital from the Company at will.
- A personal guarantee by a respective owner on behalf of the business.
- Failure by an owner to remit employee withholding taxes.
- Liability is based on the intentional wrongdoing of an owner.
- Failure to maintain the legal entity requirements or fulfill contractual or fiduciary obligations.
The two most common legal entities for a small business is a Limited Liability Company (LLC) and a Corporation.
Limited Liability Company (LLC)
The owners of the LLC are the “members” listed in the Articles of Organization. The LLC may be managed by its members or managed by one or more managers elected by the members. The governing agreement for the LLC is called an “Operating Agreement” which is a legally binding contract between the members and the entity. Even Single Member LLC’s need an Operating Agreement! Management duties include decisions about key policies, LLC transactions, and establishment of guidelines within which the business of the LLC will be conducted.
It’s a good idea to record members consent on certain decisions, as the Operating Agreement requires, but LLC’s are easier to manage since LLC’s do not have the same obligations as Corporations in observing formalities.
Corporations are owned by the shareholders who sign legally binding contracts called “Bylaws and shareholder agreements,” which define how the Corporation will be run. According to these agreements, the shareholders elect directors to manage the corporation. The directors appoint officers who carry out the day-to-day business of the corporation. The shareholders will not be personally liable for the corporation’s obligations and liabilities if they observe proper “corporate formalities.” Three critical areas of corporate formalities are shareholder decision-making, director decision-making, and separation of corporate assets from personal assets. Specific fundamental changes in the Corporation require the consent or approval of the shareholders. These fundamental changes include the following:
- Amendment of the Articles of Incorporation or Bylaws.
- Sale of all or (substantially all) of the assets of the Corporation.
- Merger or consolidation of the Corporation with or into any other corporation
- Winding up and dissolution of the Corporation.
Although board actions may be taken by written consent without a meeting, it’s a good idea to record decisions on significant matters. Matters appropriate for director action, which can be immediately approved by written consent include some of the following:
- Appointment of officers, setting of salaries, and declaration of bonuses.
- Opening of corporate bank accounts.
- Corporate borrowing and the giving of security.
- Consummation of material contracts.
- Policy decisions.
- The adoption of pension, profit-sharing, bonus and other employee benefit plans.
- The declaration of dividends or the redemption of shares.
- Amendment of the Bylaws.
- Review of financial statements of the Corporation.
- Any action which requires a shareholder vote.
- The issuance and sale by the Corporation of additional shares.
In the case of any such actions, the secretary of the Corporation should prepare minutes of the meeting at which such actions were approved or prepare the form of written consent evidencing any such director or shareholder actions.
CHECKLIST TO FORM A LEGAL ENTITY
- Consult an attorney and accountant to determine the best legal entity: A corporation or an LLC.
- Choose a company name and verify its availability within the state of the business.
- Will the name be used as a domain, trademark, or service mark? If so, consider searching separately for similar names in the marketplace.
- Apply for an Employment Identification Number (EIN)
- Prepare and sign Bylaws+Shareholder Agreement for a Corporation or an Operating Agreement for an LLC.
- Register the entity with a state office and prepare Articles of Incorporation or Articles of Organization, depending on your chosen legal entity.
Before you register the entity, figure out the following:
- What date will you open?
- When do you plan to issue your first payroll?
- Will you be selling goods or services?
- What are the full names of all individual owners? Or will other legal entities be listed as owners?
- Who will be the Registered Agent?
- What is the address of the business?
DOES YOUR LLC OR S CORP DESERVE LIABILITY PROTECTION?
Are you protected now that your entity is formed? While setting up a legal entity is essential to shield business owners from liability, it is not foolproof. The courts can “pierce the corporate veil” under certain circumstances and put your Company and assets on the line.
It is possible to avoid a disastrous lawsuit by MAINTAINING the new entity. Although it is not intended to be exhaustive, the following checklist summarizes some legal requirements for MAINTAINING a new LLC or a Corporation.
Care must be taken with these matters because there could be serious penalties for failure to comply.
- Executing legal contracts that show a separation from the owners and the new entity, i.e. Operating Agreements for LLC’s and Bylaws & Shareholder Agreements for Corporations.
- Use Consent Forms to document actions taken or decisions made.
- Local Business License and Permits.
- Annual Statement of Information. Each year, the LLC or Corporation must confirm the information filed with the state, pay the renewal fees, and provide a current list of names and addresses of the owners, officers, and the Registered Agent for service of process.
- Taxes. Check with your accountant about (1) Paying estimated Federal Income Tax; (2) Filing Tax Returns; (3) Filing Personal Property Tax returns; and (4) Sales and Use Taxes.
- Payroll Withholding. Confirm your withholding requirements with your Accountant or Payroll Company.
- Workers’ Compensation. Employers must provide workers’ compensation coverage for all employees with a few exceptions.
- Trademarks; Trade Names; Trade Secrets. Once your business crosses state lines, you should have company trademarks and trade names registered in the Company’s name with the U.S. Patent and Trademark Office. Trade secrets of the Company should be protected by obliging Company employees to sign confidentiality agreements.
- Federal Unemployment Tax. Consult with your Accountant or Payroll Company.
- Securities Law Matters. If all members of the Company are actively involved in the management of the Company and have the experience and ability necessary to manage the Company, then the interests in the Company would not constitute “securities” under some state laws or federal law. If any of the members are “passive” investors, then the offer and sale of an interest in the Company to the investor would constitute the offer and sale of a “security.” Seek counsel from an attorney about SEC requirements for such passive investors.
- Fictitious Business Names. Suppose the Company intends to transact business using a name other than that specified in its Articles of Incorporation or Organization. In that case, the Company must register a fictitious business name statement with the state of Utah as a DBA.
- Qualification in Other States. States universally require a foreign entity (one not incorporated in that state) to “qualify” before “doing business” in such state. The qualification usually consists of the filing of documents, payment of a fee, and appointment of a resident agent to accept the service of process. Failure to qualify may result in financial penalties and the inability to bring suit in the state’s courts with respect to acts and transactions in the state during the period of the violation.