What is Business Formation?
Business formation is the decisions that need to be made when creating the structure of your business. Choosing between different business structures, such as a sole proprietorship, a partnership, an LLC, a corporation, and a non-profit, will impact the future business decisions you’ll make for your business.
Choosing the appropriate business formation from the start is an important strategy for determining your responsibilities, liabilities, privileges, and restrictions. Below are some things to consider when choosing which structure works for you:
- Taxes. Business formation structures differ in the amount of taxes to be paid, who pays the taxes, and what tax exemptions apply (if any).
- Liability. Some business formation structures risk their owner’s personal assets in case of default.
- Hierarchies. Corporate ladders differ in required size and responsibility depending on the business formation structure chosen.
- Documents and Permits. Filing with entities such as the IRS and gathering necessary permits will vary depending on the type of business structure. Therefore, the annual reporting and documentation required will vary as well.
Here is an article about business formation.
Main Types of Business Structures
Limited Liability Company
A limited liability company (LLC) is a popular form of business. The business enjoys the benefits of being a corporation with reduced potential liability. In simpler terms, LLCs protect the company's members from divulging their personal assets to pay off penalties.
LLCs are pass-through entities. Members report business income or losses on their personal tax returns. This avoids the problem that corporations face of double taxation.
There are two common types of LLC structures:
- Single Member LLC. In a single-member LLC, an individual or group is registered as the business's sole owner.
- Multi-Member LLC. Multiple individuals or groups are registered as business owners in a multi-member LLC. Multi-member LLCs are required to file a federal tax return like other companies.
Here is an article on the tax implications of LLCs.
A corporation is a business entity owned by investors and a board. For for-profit corporations, the goal is for the business to be profitable in the best interest of the shareholders.
Shareholders can benefit from the ability to recoup their investment while still being protected from the potential liability of lenders going after their personal assets. There are various types of corporate structures. Some of them include the following:
- S-Corporation. An S Corp is a pass-through taxation system. Businesses don't have to pay taxes. S Corps are limited to 100 shareholders. Here is an article discussing S Corps.
- C-Corporation. A C Corp has a double-taxation system. It means that the corporation will pay its taxes. However, its shareholders are subject to personal income tax. C Corps are not limited to the number of members. Here is an article discussing C Corps.
- B-Corporation. Also called a “benefit corporation,” a B Corp is a certification for a corporation, ensuring that the company’s purpose is the public (employees, customers, suppliers, etc.) instead of its shareholders. The goal is to make a profit and benefit society at the same time. Like C Corps, B Corps have a double-taxation system. Here is an article discussing B-corps in detail.
Several people pool their resources together in a partnership to conduct a business. This can be done with varying degrees of formality but usually is formalized through a partnership agreement that stipulates partner ownership and profit/loss shares within the business.
Some types of partnerships include:
- General Partnership (GP). In a general partnership, all partners have equal rights and responsibilities. The management of the company’s day-to-day is shared between partners. Public partnerships have a pass-through taxation system, so each partner personally pays their taxes.
- Limited Partnership (LP). In limited partnerships, some partners are limited to becoming “silent partners” who are not accountable for the company's obligations. Their sole responsibility is investing money. At least one general partner in limited partnerships is responsible for decision-making. Due to their limited involvement in the business, the silent partners’ personal assets are protected from liability. It is the general partners who are risking their own.
- Limited Liability Partnership (LLP) – In limited liability partnerships, every partner is responsible for making decisions in the company. However, each partner is also protected from the liabilities of the other partners. Partners are insulated from the risk of losing personal assets if there ever is legal action against one of the other partners.
- Limited Liability Limited Partnership (LLLP) – LLLPs are limited partnerships with one unique feature: both the general and the silent partners have liability protection.
Here is an article describing partnership formation in general.
Image via Pexels by Marek Levak
You and your businesses are the same in a sole proprietorship. The upside is that the formation costs are cheaper, and you are in complete control of all decisions for the business. The downside is that you do not have liability protection and risk your personal assets.
Sole proprietorships have a pass-through taxing system, so all your gains and losses will be carried under your personal income tax. You are also eligible for the self-employed tax credit.
Here is an article on sole proprietorships.
Non-profits are established to benefit different groups of people and public institutions. Unlike most businesses, their mission statement is not solely to be profitable and typically includes the language of a certain society the business intends to serve. In addition, the charitable nature of these businesses makes them eligible for state and federal tax exemptions.
Non-profits are similar to B Corps, but they have notable differences. B Corps are owned by shareholders, while non-profits are notowned by anyone.
Instead, non-profits are overseen by a board of trustees. In addition, non-profits can hold fundraisers and solicit donations from investors to acquire funds. At the same time, B Corps are limited to traditional ways like turning to debt or selling stock.
Here is an article about non-profits.
What Is Business Formation Law?
The business law field comprises a wide range of laws, regulations, rules, and policies that define the legal process of building a business.
These laws involve contract creation, licenses and permits, observance of IRS regulatory requirements, and company operations. Business legal issues are also related to mergers, acquisitions, and other complex transactions.
Here is an article about business formation law.
How Business Formation Services Work
A well-formed business is an important step towards wealth and success. Business formation services will help you choose a business structure tailored to your business goals and help create the documents required for incorporation.
They help reduce errors in the building stage and provide you with agents overseeing your business's legal and regulatory aspects. At ContractsCounsel, our site can connect you with legal services that are right for the needs of your business.
Here is an article for more information on how business formation services work.
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