Should I form an LLC or an S-Corp?
This is one of the most common questions business attorneys get. Budding entrepreneurs spend a lot of energy on the business plan, marketing, website, sourcing supplies, and other tasks related to the business itself. They are intimidated by the legal aspects of their business. Over the next few weeks this blog will discuss some basic legal concepts for startup businesses.
One of the first questions people have is whether they should form a company. And usually the company is in the form of an S-corporation or a limited liability company (LLC).
Why form an entity? Entities provide limited liability – this means the liabilities of the company are separated from the owner(s) and if the entity is properly formed (more on this in the coming weeks) and properly run, all the owner risks is their capital investment.
Say you have a home-based bakery business without an entity (sole proprietor for one person, partnership for two or more people), and you accidentally deliver an under baked batch of cupcakes and give 30 customers salmonella. If you don’t have an entity, you (or all the partners) will be sued and your personal assets (house, personal bank account, stock portfolio, etc.) can be used to satisfy the damages. If you have an entity, your business will be sued, and only the business assets are at risk.
When is the right time? In my opinion, there are three reasons to form an entity:
Liability. If you are in a high-risk industry, especially if you deal with food, heavy equipment or children, if something goes wrong, it will be very expensive. This is the primary reason to form an entity and you should definitely form it before you open for business.
Taxes. In some situations, there is considerable tax savings to having an entity. This is an accounting question. As soon as there are tax savings, you should form the company.
Marketing. There are some businesses that are low risk (they can be protected very well by good insurance and good form contracts) but it looks more professional to have “LLC” after the name of the business. This is a valid reason to form a company, and you can do it at any time.