You’ve launched a startup or are in the planning phases. You understand your market, your customers, and your competition. But just how much do you know when it comes to incorporating your business?
For most new entrepreneurs, the process of incorporating (forming an LLC) is an unfamiliar road to navigate. When you’re burning the candle at both ends to get a beta released or website launched, legal paperwork isn’t necessarily high on your priority list.
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Yet, you’ve got to give serious consideration to your business structure…and the sooner you address the question, the better. To that end, here are answers to some of the most commonly asked questions faced during the process.
Why do I need to incorporate?
Many startups and small businesses consider themselves ‘too small’ to worry about incorporation. However, incorporating or forming an LLC is a smart idea, even if you’re a self-employed consultant. Here’s why:
- Liability/personal asset protection: Without incorporation, your own personal savings and property are at risk to settle any debts of the business. Once your business is a corporation or LLC, it becomes a separate legal entity. This means that the corporation (and not you) is responsible for all of its debts and liabilities. Of course, lawsuits and payment defaults are worst-case scenarios and there’s a slim chance you’ll ever run into these problems. However, if you’re sued as a sole proprietor, you’ll be sued personally. And that means everything, from your children’s college fund to your retirement savings, is at risk. Also keep in mind that creditor judgments can last up to 22 years, so you need to worry about protecting the assets you have today as well as tomorrow (and a lot can change in 22 years!).
- Tax benefits: Liability protection is the key benefit for incorporating or forming an LLC, but in some cases, forming a corporation can help you lower your overall tax burden. And corporations and LLCs often qualify for additional tax benefits and deductions that aren’t available to individuals. Of course, specific circumstances vary, and you should consult with a CPA or tax advisor about your own particular tax situation.
- Added layer of privacy: When you incorporate or form an LLC, there’s an added layer of privacy. In many cases, the registered agent of your corporation goes on record, not your home or business address.
- VC funding: A corporation offers a known stock structure with freely transferrable shares, which makes it attractive to investors. If you’re planning on pursuing VC funding, you’ll need to incorporate. Additionally, as a corporation or LLC, it can be easier to access a line of business credit.
- Other benefits: As a corporation, you can offer more employee incentives, such as stock options, group health insurance plans, 401k and other retirement plans, and more.
Where do I incorporate?
You’ve probably seen that many companies choose to incorporate in Delaware or Nevada. There’s a good reason why these two states are hot choices for incorporation. Delaware offers very developed, flexible, and pro-business statutes, while Nevada has low filing fees, and no state corporate income, franchise, or personal income taxes. However, these states aren’t for everyone.
If your corporation or LLC will have less than five shareholders or members, it’s best to incorporate or form an LLC in the state where your business has a physical presence. “Physical presence” can be the state where your business is physically located, where any property owned by the business is located, where your employees reside, or where the shareholders reside. Unless your business has some kind of physical office in Delaware or Nevada, it’s going to be much easier (and less expensive) for you to incorporate or form an LLC in your home state.
For starters, there can be logistical challenges when you try to open a bank account in your own state if you’ve incorporated in another state (i.e. Delaware or Nevada). And there are added fees to deal with. For example, if you register in Delaware (or any other state), you’ll need to qualify as a Foreign Corporation in your own state. While Nevada may not charge state income taxes for your corporation, the state where your business is physically located will come after you for those taxes sooner or later.
Adding insult to injury, your tax liability may actually increase because you’re viewed as a foreign entity operating in the state. If you’re a small business owner, you’re already contending with enough paperwork and fees as it is. Don’t add more to your workload. Remember the rule of thumb: If your company has less than 5 shareholders/members, incorporate in your home state.
How do I incorporate?
It’s important to know that the process to incorporate or form an LLC is relatively easy these days. There are 3 common methods and each has its own set of pros and cons depending on your specific situation.
- Do-it-yourself: With this method, you’ll need to download (or request the forms) from your secretary of state’s office and submit the forms on your own. DIY is obviously the lowest cost method (you’ll still have to pay the state filing fee; exact fee amounts vary by state; for example, in California it’s $115 for a Corporation and $85 for an LLC). If you’re more concerned about saving money than time, and have a high tolerance for following the tiniest of details, this is a good option for you.
- Online legal filing service: An online legal filing service will file the documentation for you. This option is slightly more expensive than filing yourself. Yet for some, the time savings and peace of mind are invaluable. Legal documents are tedious and full of details (right down to what paper size a particular state requires!). A professional online service will know exactly what is needed to make sure the application is filed right the first time.
- Attorney: If you have particularly complex business needs — for example you have strict requirements for shareholder structure or stock allocation, or you’re dealing with millions of dollars up front — you should retain your own expert counsel to help get you started. Hiring an attorney is the most expensive option, but for some situations, it’s called for.
Since the main benefit of incorporation is liability protection, the sooner you incorporate (or form an LLC), the better. There’s simply no reason to wait and potentially expose yourself to any more liability than you need to. Invest some time now to get your legal structure squared away and your business will be set for years to come.