There are so many things that go into starting a business on top of your skill or craft. Will Kariker, attorney with Legal Aid of Western Missouri in St. Joseph, MO joins me today to discuss the legal side of entrepreneurship.
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Brandon: What does it mean to incorporate?
Will: Incorporation means creating a distinct legal entity that is distinct from the individual who is forming (or incorporating) the entity. So whether its an LLC or some form of a corporation it means making the required filings. Corporations are creatures of state statutes. So it involves filings with the state that you’re in and depending on the type of corporation that you create, doing what is necessary under state law to keep the corporation going as a legal going concern.
Whether you have a lot or a little, the question is do you want to put any of your assets in jepordy by not insulating yourself individually from liability?
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Brandon: Without getting too deep can you tell me what the difference is between a Sole Proprietorship, Limited Liability Company (LLC), C-Corp, S-Corp? How do you know which one to choose?
Will: A Sole Proprietorship is literally just [your name here] going out into business in his own name. There’s no corporate form that’s involved. If you choose to do business in your own name, of course you would want insurance. You would want to make sure you’re covered as best you can with insurance to prevent liability the best you can by virture of the coverage you purchased. But otherwise you’re just on your own with not a whole lot of legal protection.
Brandon: And this is a Sole Proprietor that you’re talking about?
Will: That’s right.
From a legal standpoint, if you create an LLC or if you form a corporation, whether it’s a C-Corp or an S-Corp, the primary thing you’re getting out of that is you’re limiting your liability. By that I mean – this is the fundamental aspect of what I’ll call incorporating as you put it earlier. Whether it’s actually forming either a C-Corporation or S-Corporation or an LLC (which is not the same as a corporation).
What you’re doing with any of those entities is limiting your personal liability. An LLC as you referenced is a Limited Liability Company. Similarly with a C-Corp or an S-Corp, what you’re doing is as I said as the very beginning you’re creating a distinct legal entity. Having its own tax ID number. Its own name. It would be an entity where you’ve made required filings with the Secretary of State (in whatever state you’re doing business in). The upshot of that is if their is any incident that could result in liability…say you’re an LLC…a contractor. An accident happens. A ladder falls and hurts somebody. If the works that’s being done is in the course and scope of the work done by the LLC then it would be the LLC that’s liable. Not the individual. So if any lawsuit was filed or any claim was made against the LLC, it would be just that, a claim against the LLC. Same thing for a corporation.
So that’s the primary benefit that a person would get from forming an LLC or a corporation.
Brandon: Is it safe to assume there are some tax implications that you would want to talk with your accountant about?
Will: That’s right. I’m glad you put it that way, because I’m not an accountant. I know enough about tax law to recognize when someone should talk with their accountant about the tax implications of doing what their doing.
Whenever I meet with a client and the purpose of the meeting is to talk about corporate issues, I always recommend that they discuss the issues with their accountant as well. Sometimes even simoultaneously. In other words, they would bring their accountant and we could meet together to talk about the issues from a legal standpoint. Which is where I can be helpful and from a tax standpoint. Where the accountant can be helpful.
Brandon: You’re talking about the Sole Proprietorship and how it’s just an individual. If I started my own business and I didn’t form a legal entity, I would be Brandon Tritten Doing Business As Acme Gutters. What’s the importantance of separating business from personal in this instance?
Will: The importance of forming an LLC or Corporation is limiting your indivdual liability. If that ladder falls and I’m just Will DBA and I’m doing work at someone’s house…I should have insurance. If I don’t then I’m really in trouble because I’m just out of pocket for whatever happens. If I have formed an LLC though…I keep referencing the LLC though…The LLC is probably the most…In most cases with a small business, whether it’s a contracting business or even someone that wants to rent residential real estate. An LLC is probably the most common form of incorporating so to speak. It’s very simple to do. There are no corporate formalities. An S-Corp or a C-Corp you have corporate formalities. Filing annual reports, having annual meetings of shareholders, etc.
The LLC requires a lot less for the people involved. That’s probably the most prevelant form of incorporation.
If I’ve formed an LLC and I have an incident that could create liability then the LLC, which should have insurance in the name of the LLC, would be on the hook for damages.
If I’m keeping the books properly and not commingling my personal assets with the LLC’s assets, I’m at no risk personally of having my house, my bank accounts, anything of mine personally being lost to a claim or in a lawsuit, a judgement because of my liability.
Brandon: What if you’re a small business and you don’t have much in way of assets, is it still important to create an LLC or a legal entity?
Will: I think it’s always advisable because whether you have a lot or a little, the question is do you want to put any of your assets in jepordy by not insulating yourself individually from liability by forming an LLC. Because if you have a lot, maybe you can withstand something, but it depends on the severity of the potential loss.
If you’ve got a little and that gets wiped out, then you’re looking at bankruptcy and starting over.
If you can afford to go into business and you’re wanting to take that risk, it makes sense to spend a little bit more to protect yourself even further by forming an LLC or incorporating.
The filing fee for filing the Articles of Organization, which are the foundational documents for an LLC is $105.00 with the Secretary of State’s office. And if you file electronically I think it’s $51.00 or something like that. So it’s a pretty minimal fee to at least do that much to protect yourself.
As far as forming a corporation, there are two types like we talked about. A C-Corp and S-Corp.
The C-Corp is probably almost never advisable, escpecially a small business. You have the corporate formalities that I talked about and with a C-Corp you have double taxation. Which is taxation at the corporate level as well as what is passed on to shareholders. Again, you would want to consult with your accountant before making a final decision on that. It’s hardly ever the preferred method for somebody starting out with a small business.
Alternatively, an S-Corp has got the corporate formalities, but if you are thinking of expanding you have the ability to sell shares. Which is the benefit of a corporation. That allows you to bring in more capital by selling shares. It doesn’t have double taxation. It’s similar to an LLC in that the income for both an S-Corp and LLC is imputed to the shareholder or the member for an LLC.
Brandon: Have you seen a small business or Landlord, where they’ve had a business in their personal name and had a lawsuit? Do you have an examples of someone that has experienced that?
Will: I guess I don’t really have any horror stories that I’ve experienced yet. Typically when I talk to clients they recognize that it makes sense to form an LLC or a Corporation or they don’t.
The other thing that’s a consideration is if you’re borrowing money in your corporation and then you sign a personal guarantee (I know we’re kind of getting outside the scope of what we’re talking about), but that is actually a situation where I’ve had a few different clients that have had trouble with personally guaranteeing essentially corporate debt.
Now, a lot of lenders won’t provide financing without a personal guarantee. But if you’ve formed a corporation and you can borrow money in the name of the corporation or the LLC without providing a personal guarantee that’s of course advisable.
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Music Credit: Sandr – Miles High [Argofox]
