Selecting a Business Entity – Think it Through

You’ve decided to form a small business and are worried about liability among other things. The obvious answer is to form a business such as a corporation or limited liability company…or is it?

There is a certain innate momentum that happens with commonly understood concepts. When it comes to starting a business, everything you watch/listen to/read will tell you to form a business entity for tax and liability purposes. Depending on the source, a great amount of bleating will then be undertaken discussing whether the corporation or LLC is the best entity to go with for your business.

You will note I use the word “bleating” in the paragraph above because that is exactly what is occurring. The concept of using a business entity is so engrained in the business mentality that many people form one without really thinking the process through. This can result in catastrophe when things go wrong or the incorrect positioning of an entity when things go right. Let’s consider a simple example.

Why do you incorporate your business? The common answer is to protect you from personal liability should a lawsuit or debt arise from the activities of the business. Nobody can argue with that, right? Not really, but the problem is that argument entirely misses the point in many ways. How so? Well, what if your biggest assets are in the corporation that is getting sued?

Assume I come up with the concept of Google. [I wish.] I form a corporate entity. I am now protected from personal liability for the debts of the business. Lucky me, but what about the really valuable assets? Google has many valuable assets ranging from the name to the servers to the patented advertising systems and so on. Well, guess what? If Google gets sued, all those assets are exposed to the lawsuit. Sure, I get to keep my house, but how will that measure up to the fact I just lost control of the Google search engine? My home will be a nice place for the wake after I throw myself off a bridge somewhere!

Should you form a business entity for your business? Yes. The question is what do you really want it to do. If the business will have a lot of valuable assets, say manufacturing equipment, then just incorporating isn’t really doing much for you because it leaves all that manufacturing equipment exposed. Might not it be better two form one business entity to own all the valuable assets and another entity to lease those assets and carry out the main business idea? Of course.

When it comes to creating an entity strategy for your business, don’t stop at the idea of protecting yourself from the liabilities of the business. Many times, the business assets are far more valuable than anything you own. Take the time to think it through. Try to separate the risk from the value. Once you do, then you will know the entities you need and how to proceed.

The Perfect Business Entity For Passive Investors

Business entities are some of the most misunderstood legal tools on the market. Many people just form them because it is something you are supposed to do. In truth, the various entities are designed for specific purposes. Let’s consider a common scenario.

You’ve come up with the greatest business idea since sliced bread. The only problem is you need some capital to get the business off the ground. You’ve found a few investors who are willing to pony up some money so long as they are not put in a position of risk. Now what?

This happens all of the time. The passive investors are usually friends and family members. They are willing to help out, but remember some of the more “interesting” events of your youth and don’t want to risk their homes and so on. Is there any particular way to go about meeting the goal of getting your funding without putting them at risk? Of course.

Our magic entity is known as the limited partnership. To understand the value of this entity, we first have to step back and discuss the concept of a general partnership.

A general partnership is a business venture undertaken by two or more people for a profit so long as no other business entity, a corporation or limited liability company, has been designated as the official business. A general partnership may exist even if the two parties don’t put anything in writing. The classic scenario of two kids selling lemonade in the front yard is an example of a partnership.

The advantages of the general partnership are two fold. First, they are not formal entities. You can pretty much do everything orally and not run afoul of any laws regulating how a business entity should work. Second, you can pass the tax liability directly down to your personal taxes, which lets you avoid double taxation issues that arise with other entities.

The downside to a general partnership, however, is found in the liability area. Basically, a general partnership provides you with none. If the business gets sued, your home, car, bank account and so on are all on the line. This represents a huge risk and is one of the reasons a general partnership is frowned upon by most people when it comes to selecting business entities.

A limited partnership takes the best aspects of the general partnership and mixes them with a dash of the advantage of incorporating. It works like this. There is a general partner. That partner then sells limited partnership interests. People who buy the interests cannot participate in the running of the partnership. The can only collect profits when the general partner decides to do distributions. In exchange for this passivity, the limited partnership can only lose their investment in the limited partnership and nothing else. In short, they get the same protection afforded a shareholder in a corporation.

So, why is our limited partnership such a magic entity? Well, go back to our initial scenario. We have passive investors who are willing to pony up money, but do not want to put their personal assets at risk. If you form a limited partnership, this can be accomplished by having them by limited partnership interests. You get the money and the only risk they face is the loss of the money they paid for the interest.

Definitions of Business Entities in Indonesia

There are several different business entities recognized in Indonesia. These entities differ due to their legal status, composition, purpose, financing, and even membership. To discover what types of business entities exist in Indonesia and to aid you in choosing one which will best serve your needs, here is a short description of various business entities in Indonesia.

PT (limited liability company): a legal entity established under an agreement, which conducts business activities with a capital based entirely of shares.[Article 1(1) of Law No. 1 of 1995]. The wealth of a PT is separated from the wealth of its owners, and the latter holds limited liability; only as much as the stock holds. Profits will be divided among shareholders by means of a dividend depending upon the amount of profit the PT earns.

CV: Commanditaire vennootschap; a partnership created by an individual or several individuals who trust money or goods upon another individuals or other individuals who run an enterprise and act as the leader. It is formed by means of an authentic deed, which is subject to be registered to the Clerk of a State Court where the firm is located and then the deed of establishment must be published in the Additional Official News of the RI. Despite being a business entity, a CV is not a legal entity for lacking in formal acknowledgement from the State in the form of laws.

Koperasi: An enterprise comprised of individuals or a legal entity, basing its activities upon the principles of cooperation as well as a manifestation of the people’s economic movement which is based upon the principle of familial. [Art. 1(1) of Law No. 25 of 1992]. A koperasi is operated based upon the Pancasila and the 1945 Indonesian constitution, and aims to achieve the prosperity of its members, first and foremost, and the society in general. A Koperasi is comprised of a minimum of 20 individuals, and its membership is open and voluntary. It is run democratically, providing a limited reward for investment, and its members are rewarded with the Koperasi’s profit with a share which commensurates with the amount of each of their own contribution.

Foundation: A legal entity encompassing wealth which is separable and is intended to achieve a certain goal in social, religious, and humanitarian areas, which do not have members.[Art 1(1) of Law No. 16 of 2001]. A foundation is comprised of Trustees, Managers, and Supervisors, and it erect a business entity or join one to raise funds for its cause, but the trustees, managers, and supervisors may not monetarily benefit from it.

Choosing the Right Business Entity: LLC Vs S CORP Vs C CORP

Choosing the right business entity is a very important decision all prospective business owners have to make.

The right business entity should provide the following:

Personal liability for the owners
Minimize business taxes
Means of financing

To simplify this process, we will determine the right business entity from a tax perspective. In other words, the ideal business entity will be the one that produces the lowest business tax.

The three business entities we will choose from are: Limited Liability Company (LLC),S-corporation, and C-corporation.

LLC vs S CORP vs C CORP

The first process of elimination is based on the profitability of the business. If the business is not profitable, then an S corporation or C corporation are NOT suitable options. An LLC will be the right business entity to pick.

In this article, a business is considered profitable if the owner can take out a market salary from the net profits.

An example to illustrate the profitability test is shown below:

John is a CPA who owns a tax consulting business called Tax Guru. If the market salary for a CPA with John’s experience is $60,000 and Tax Guru generates profits of only $40,000, then Tax Guru Fails the profitability test and should be set up as an LLC. Now if Tax Guru had profits equal to or greater than $60,000 it is considered a profitable business, and should be set up as an S Corp or a C corp in order to minimize self employment taxes.

S Corp vs C Corp

We’ve already established from the previous section in this article, that a business must be profitable in order to be set up as an S corp or a C corp.

An S Corporation is suitable if the following apply: business owner is not in the highest tax bracket, the business owner has a significant amount of qualified dividends and capital gains, the business expects a loss in the future, and the business does not have a need for public financing.

A C Corporation is suitable if the business owner is in the highest tax bracket, or the business has a great need for public financing.

Disclaimer

The foregoing is intended for educational purposes only and does not constitute legal or professional advice. Nothing contained herein is intended to be used, or can be used, by any person to avoid penalties that may be assessed under federal or any state law.

Business Entities: Which One Is Right for You and Your Business?

Many entrepreneurs are concerned about liability when starting their business. However, many of those same entrepreneurs fail to follow through on those concerns. Those concerns usually start with what type of business entity they should form. From a sole proprietorship to a corporation, entrepreneurs need to understand what each of these entities will mean for them and their business.

A sole proprietorship is the most used and inexpensive type of business entity. Most businesses start in this form because of the low cost and ease of formation. All it takes is a trip to the county clerk’s office and less than twenty bucks and you are in business. A sole proprietorship is a business that is owned and operated by one person. Typically identified as an “assumed name,” it is a way of operating a business under a different name other than the business owner. If you have a low risk business or intend to keep the business as small or part time operation, this could be a viable option.

The best thing about a sole proprietorship is the ability to have control and make decisions by yourself. You are the business and the business is you. There is no separation between the two. There are no requirements to maintain minutes or other formalities. You may file your personal tax return form 1040 and simply add a schedule C. Depending on the amount of income you make by running the business this can be simple and inexpensive option.

The same benefits of operating as a sole proprietorship also act as serious liability traps. Because there are no distinctions between the owner and the business, the owner’s personal assets are at risk along with the business’ assets. This means that if there is ever any liability that is associated with the business, it will be associated with you as well. Moreover, you will be taxed on your individual tax level, which means that if you have a lot of personal income (i.e. salary from other employment) and are in a higher income bracket, you will have to pay taxes in that higher bracket.

If you are operating a business with high risk you should not operate as a sole proprietorship. Furthermore, you have a lot of personal assets or your business acquires a lot of income a sole proprietorship should not be your entity of choice.

Ideally, if you are going to enter into a partnership, you should have a written agreement which is drafted to accurately reflect the agreement. Sadly, many perspective partners fail to focus on this issue. Sometimes the partners are friends and/or family and believe that there will never be any disagreement. However, it is my experience (as well as most business attorneys) that this belief often leads to disaster. It is always prudent to spend the time and money on a proper partnership agreement that will guide the partners through the good and bad times. A properly drawn partnership agreement will prevent disagreements from getting out of hand and will cut down (if not prevent) costly litigation costs in the end. The time and money that you are willing to spend properly drafting an agreement will well worth it.

General Partnerships are formed by either an oral or written agreement. Based on the foregoing paragraph you already know which I think is best. This entity is relatively inexpensive to form because there is no requirement to file documents on the state level. The partners will have to file an assumed name certificate with the county clerk’s office in the county which it operates business. Much like the sole proprietorship, there is generally no distinction between the partners and the business. Unless there is a written agreement to the contrary, each partner has equal management rights and equal opportunity to run the business. Partners are accountable to each other and to the business. General Partners are equally and severally liable for the debts of the business. This means that there is no distinction between the partners, their personal assets and the business. Everyone is accountable for the business.

Limited Liability Partnerships (LLP) require written agreements. LLPs are filed on the state level and require annual filings with the state. LLPs are good entities for professionals such as lawyers, accountants, and financial advisors. An LLP will limit liability for each individual partner to the extent that he/she is not personally liable. This means that if one partner commits malpractice, the other individual partners will not be held liable. Furthermore, if the partnership is sued and does not have sufficient assets, the individual partners (in most circumstances) will not be held liable. LLPs are expensive to create and require insurance before the filing can take place.

Limited Partnerships (LP) are good entities to bring in investors. Most commonly identified by laymen as “silent partnerships,” a LP will allow a partner to invest money without incurring liability for the company debts. The LP must have at least one general partner that will assume the liability for the partnership. This partner will be responsible for the day to day operations of the company and are solely responsible for the decision making. By contrast, the limited partner cannot be involved in the day to day operations of the company if it seeks to protect its limited liability. The limited partner will be entitled to profits and to be informed regarding the financial position of the LP. The LP is also required to file documents on the state level and requires a written agreement.

The most common and well known business entity is the corporation. Usually most entrepreneurs choose this entity because this is all they know. While it is not a bad choice making this choice comes with much responsibility. Incorporating your business requires a filing with the Secretary of State. Articles of Incorporation, Bylaws, Employer Identification Number, and meeting Minutes are all mandatory documents. A corporation usually has what I would like to call a “three tiered management system.” Shareholders are the owners of the corporation and elect the Board of Directors; the Board of Directors oversee the overall direction of the company and elect the officers; the Officers run the day to day operations of the business.

In a traditional corporation, the shareholders do not run the business but only receive income from it. Shareholders are shielded from the liability of the corporation. A Corporation has its own legal identity, separate from its owners. It exists separate and apart from the people, who own, manage, control and operate it. The Corporation issues stock of its own as evidence of ownership. The persons who own the stock are the owners of the Corporation, and are entitled to any dividends the Corporation may pay and to receive all the Corporation’s asses after all creditors have been paid if the Corporation is liquidated.

Board of Directors and Officers generally manage the Corporation. The shareholders, Board of Directors, and Officers must hold annual meetings and keep records of each. This can become relatively expensive if there are a large number of shareholders who do not live in the same area. The Bylaws govern the rules and regulations of a particular corporation. Board of Directors makes decisions, officers carry them out.

Another popular choice is a Limited Liability Company (LLC). A LLC is an unincorporated business entity that shares some aspects of the “s” corporation. The LLC provides its members with limited liability and pass-through tax advantages without the restrictions imposed on “s” corporations and limited partnerships. The LLC is owned by member and may elect managers to run the company. The management and operation of the LLC is governed by its regulations, which are similar to corporate bylaws. Members of an LLC are agents of the LLC to the extent the articles reserve management in the members. If management is vested in managers, then they are the agents of the LLC to the extent the articles vest management in them. An agent of the LLC has power to bind the LLC by an action apparently for carrying on in the usual way the business of the LLC.

Members of an LLC are not liable for the debts of the LLC except with respect to make the contributions to the LLC that they agree to make and with respect to the distributions received by the members when they knew the distribution caused the LLC’s liabilities to exceed the fair market value of its assets.

Business Entities – Which One To Choose?

Business entities like businesses come in many shapes and sizes. Depending on what kind of business you have, you may be limited in your choice of entities for that business. A short and to the point definition of an entity for your business, is a business that is created to make money. This business can be owned by a single owner, or a several owners. Depending on where your business is located, you may have to meet some legal requirements for your business entity. Let’s review the different kinds of entities for you to choose from.

Sole Proprietorship

One type of business entity and the most common that you will find is the sole proprietorship. Which is a business that is operated and owned by only one person. The owner is the one that benefits from all profits made by the business, but also resumes all responsibility for it as well. If you are not looking to go into business with anyone else, and just for yourself, this may be the ideal entity for you and your business.

General Partnership

When you have more than owner for your business, the entity you may want to consider is called a general partnership. This type of company is owned by more than one person, which all share in the profits made by the company, as well as all of the responsibility that the company requires.

Corporation

A corporation is a business entity that has a board of directors. The board of directors make the major business decisions and vote on changes for the company. The money that is made from a corporation is split with the shareholders of the company.

Limited Liability Partnership

Another type of entity to consider for your home business is the limited liability partnership. This business is a lot like a corporation with the exception of the board of directors. The owners can either manage the business themselves, or offer that position to someone else.

Limited Partnership

A business entity that is called the limited partnership is owned by general partners which are active in the company, and limited partners which are more or less just investors. This type of company is ran by the general partners, and the limited partners are somewhat limited in the role that they can play in the company.

With all of the many business entities that you can choose from, you are sure to find the best one that suits the business that you want. Be sure to thoroughly research each one of the entities and make sure that you are following all of the laws in the state that you are doing business in.

What Types Of Business Entities Are There?

It’s rare for the average Joe to know what a Business Entity Search is without having it explained to them, but once they do, they usually retain it. The same concept that’s true in our relationships with the opposite sex and society at large applies to our dealings with other businesses: we all want to work with somebody we trust. A Business Entity Search helps you to find whether a certain company has potential for fraud or not, by checking their details in state and local databases. Further, it helps you locate whether the business has shut down or is still functioning.

Categorizing Entities

There are many forms and types of business entities, and the all fit in the following broad categories:

Sole proprietorship – This is a type of business entity where there is only one sole owner and there is no legal difference between the owner and the business. This is probably the simplest entity – the owner does all the work, he gets all the credit, he takes all the profits, he absorbs all the losses, and if there’s any legal liability – you guessed it, he’s all on his own. On the positive side, a sole proprietorship comes with the least amount of paperwork, and you can use your business expenses as a tax deduction. On the downside – If you get in debt and default, the creditor can dig into your personal assets for recovery.

Partnership – this is a legal entity which has more than one owner bound in a contract. The profits and losses are shared according to terms stated in that contract, but they have unlimited liability i.e. their personal assets can be targeted in case of default. This type of entity has the advantage of having larger capital than sole proprietorship, as more than one owner is involved. But it comes with disadvantages – partnerships can fail, and people can be unpredictable. I’ve seen more than one business partnership fall apart because a partner got too fond of billing things “to the business” and drove his partner to the poorhouse.

Private limited companies – this is the first type of legal business entity with limited liability, i.e. the personal assets of the owners cannot be used in case the business goes bankrupt. It requires fairly large amounts of capital, and the business ownership is divided among a group of private shareholders. The shares are generally sold within the company, and hence the decision-making (and the money) is not to be made public. These entities are treated as an individual separate from the people involved in the day-to-day operations.

Public Limited Companies – this is the largest type of business entity in terms of capital. The capital comes from public shareholding, as the Public limited company needs to be registered with a stock exchange. They have unlimited liability and usually the ownership is separate from management. They are required to show their financial statements, shareholder meetings, and performance publicly once a year at least, hence decision-making is not private. Failure to keep up those standards could get a corporation stripped of its personhood – an ugly experience for everyone involved.

Each business entity has its own rules and regulations. Why’s that important to a prospective searcher? Well, when an investor is ready to open her checkbook, she can check the viability of her investment according to the legal form of business. After all, all business entities, either having limited or unlimited liability, need to be registered with their state.

Once you’re know what kind of business entity you’re dealing with, it becomes a lot easier to get information from other databases.

Costly Mistakes Made With Your Business Entity

Investing in a powerful tool and not using the tool properly does not make a lot of sense. I know when it comes to running a business it requires multiple hats to wear and very often you are off and running on 10 different projects, calls, appointments, presentations… and perhaps the very foundation of your business may be in jeopardy. Here are the top costly mistakes I have seen made over the past 15 years:

Not completing the transition from a sole proprietorship to a separate legal entity. If you started a business in your own name for a few months before you formed an entity odds are part of what you did you completed as an individual and you need to connect the dots to the new entity. If you filed a DBA (doing business as) with yourself as the applicant that needs to be cancelled and re-linked to the entity. That means your entity needs to be the applicant, not you! If you don’t do this you still are exposed to unlimited liability and filing a schedule C with a higher audit potential. Next, point is to open a bank account in the name of the business, not just keep the account in your personal name. Use a business credit card in the name of the entity, not just your personal credit card and keep track of expenses. You will want to minimize the amount of debt that shows up in your personal name. Update all affiliate programs, vendors with your new entity information so any income is going to your business entity, not to your name personally. Update your websites, business cards, letterhead with the new name of your business. Another important tip make sure your website is in compliance, most are not.

Funding concerns. 95% of businesses fail within 5 years and undercapitalization is the #1 reason. The pattern I have seen is that small business owners are mostly hoping for revenue to come in as the primary source of money to grow their business. What happens if your revenues are off or don’t come in at all? You may be working on that great new product and all your emails go out and no one converts. That is a real problem. The key is to model success. Almost all successful companies do not use only their own money to grow. I know you know the concept, “OPM”, other people’s money, yet are you doing that? Are you only self funding your business on your own personal credit? Did you know that once the entity was filed the business credit bureaus will start creating a file. They scan the Secretary of State’s records to create a file with any new filings. They look for the name of the business, the start date, and name of the officers/managers the address… If you are not paying attention on how you fill out forms with the business address, business license, state forms you can create disconnects in the database. In one business credit bureau, NCP is spelled four different ways. The NCP part is the same, but one way has “Inc.”, one has “,Inc.” other has “, Inc” and the last one is “Inc”. Did you notice the differences with the comma and period? That created four different files! Don’t make that same mistake. Unlike the personal credit bureaus, the business credit bureaus are very difficult to fix any mistakes. They have their own set of rules and are not set up for changes after mistakes happen. This creates a problem when it comes to developing credit for your entity because you basically have one shot at the apple to get it right the first time. Banks and vendors are very interested in your financial strength of your company. Now joint venture partners can check you out for free to determine who stable is your operation. You may be losing business and not knowing it. It is really a must to be financially solid in your business and your developing business credit is a must for your long term success.

Safe and risk asset. Mixing asset classes is a major risk to your wealth that is unnecessary. A risk asset is any asset that would cause liability to your entity. That may be a business, real estate, equipment, again, anything that may cause liability to an entity. A safe asset is one that does not cause liability to an entity, like cash, ownership of another company, investments… If your business falters and you need to reply upon your safe assets to recover short term, why unnecessarily put your safe assets at risk? It happens all the time. There are two reasons this may be happening to you, first, you have thought that your amount of safe assets are not large enough to protect. Imagine having $25K in a brokerage account in your name and losing all of that because of a personal lawsuit. Wouldn’t you wish that you took the time and invested a small amount to protect that amount? Most clients will tell us they will get to it later but never do. Don’t make that mistake. Set in place a safe asset LLC in your home state and transfer your safe assets into it immediately. This LLC does not have to be based in Nevada, because the protection of the entity veil is not important in this situation because as a safe asset entity there should be no one to sue the operating entity because there are no public clients! This is why your home state is fine for a safe asset LLC.

Now clear on who does what? A partner can help you grow a business quickly and destroy it even faster if you are not on the same page. Very similar to being married. I have been married for 16 years with three girls and it is a lot of work and requires meetings, discussions to do the best to be on the same page. Business like marriage can be very exciting at first and you really need to be able to communicate well as to what you are looking to accomplish. The fun part of business is discussing how you will bring in revenue and all the possibilities that can happen with profits. The part that is not a lot of fun is the expense side of the ledger. First, you must agree upon what is actually considered an expense, does that include things like cell phones, travel, meals… ? You may assume this is obvious but typically that is not the case. What happens if revenues are way off and there is not enough money to pay each partner and you need more capital from each partner to keep it going? This can be a very uncomfortable problem. It is best to presuppose the challenges ahead of time and see if you can calmly discuss through them and come up with solutions that make sense. If you can’t get to first base on the uncomfortable parts even before you get started that is a bad sign and perhaps you should NOT be a partner. If fact, odds are the business is doomed to fail if you can’t get through some of these basics uncomfortable discussions from the start. Now, that does not mean your partner is telling their spouse the same story. That can and often does create more issues. Having as much in writing from the start and a business plan in place makes the most sense. Almost ALL, not all, but close, partnerships that refuse to take the time to put things in writing fail. It is like clockwork. If anyone wants to start a business with you and they refuse to put things in writing, run! Most of the time the only one that makes money in that situation is the attorney’s after the partners sue each other! Take the time to be clear and put it in writing!

That is your top 4 of the most costly mistakes that can be made with your business entity. There are more, but these are the biggest. The key is to take a few minutes and determine if any areas you are making mistakes and if so set an appointment on your calendar now to solve them!

Choose the Right State For Your Business Entity

I have helped thousands of people set up Limited Liability Companies (LLCs) and Corporations in Montana and a few other states. Being a Montana attorney, the majority of the LLCs and Corporations I have helped form have been in Montana. For certain reasons, I have advised clients to form their business entity in another state, sometimes sending business away because it was in the best interest of the client.

Of the LLCs I’ve helped form, many have been for non-Montana residents to use as holding companies for vehicles. This strategy is useful for certain people to minimize tax and registration fees depending on the use of said vehicle. Other LLCs I have helped form have been for various profit enterprises or holding companies for real property, both rentals and private property. The LLC is an extremely versatile business entity and a preferred entity for many uses. However, because I have helped so many people with LLCs, I also get a flood of calls regarding LLCs and their use that is not in the best interest of the person calling. Therefore, I do spend a fair amount of time educating people on the benefits of LLCs, and most important, where to organize the entity related to their goals.

The organization of a Montana LLC is great for the tax and registration savings on a vehicle as long as the person operating the vehicle complies with the State laws of the operator’s State of residence and the use of the vehicle. The organization of a Montana LLC is great for a Montana based for profit business. It is also a great entity to own real property located in the State of Montana.

The problems arise when people from different states want to use a Montana LLC to own real property in different states, or to do business in different states. Yes, the LLC is a great business entity to use for asset protection, tax, and liability purposes, however, it must be organized in the right state to provide the most benefits.

My home state of Montana is a great state for vehicles because of the sales tax laws. Nevada is promoted all the time as the State to form business entities for income tax and asset protection reasons. And there are tons of promoters and services that will help you form these entities without providing you any guidance of the law. Sure they are experts at forming business entities. That means they can file the proper forms for you. But have they advised you on the law? I strongly suggest you speak with an attorney rather than some of these other promoters. Recommending everyone set up a Nevada entity, or a Montana entity, is poor advice at the least, and it may cost you much more in the end than paying an attorney up front.

This is why it is poor advice and may cost you. You might not have any liability protection at all! Yes, that’s right, the entity you set of for liability protection might not provide an ounce of that protection. Each State’s laws are different, so you really need to talk to an attorney in the state you reside in or are doing business in. However, in general you need to know that the asset protection and liability protection provided by a business entity is only provided by the State that the entity is formed in or registered as a foreign entity where the entity is doing business.

This means that if you are operating a for profit business with a Nevada or Montana business entity in a state other than Nevada or Montana and you have not qualified the business entity to do business as a foreign entity with that state’s Secretary of State or governing body, there is most likely no protection. If a business entity is doing business in a state where it was not created and was not qualified as a foreign entity, the owner or owners of the business may be held personally liable for any debt or obligation incurred by the entity.

Therefore, I usually recommend to people that they form business entities in the state where they will do business, and form business entities for owning real property in the state where the real property is located. If you are going to use a business entity formed in a different state, you need to qualify it in the state where you will do business or own real property. (This means paying the correct fees and filing the required documents to both states)

For certain situations, there are advantages to forming business entities in Montana, Nevada, Delaware, etc. However, it really depends on what the goals and objectives for having a business entity are, and where you will be doing business or purchasing assets. If you don’t do things right, you may not have the protection you believe you have. Do yourself a favor and seek out qualified advice before forming your entity, and remember that there is no single solution, single business entity, or single state that is best for everything or everyone. Do a little homework, ask qualified people, and you will be able to maximize the use of your business entity to satisfy your needs and goals.

Learn the Differences Between Each Legal Business Entity Type

Your individual state will register your legal business entity, and it’s important to understand that not all states recognize every business entity type. The descriptions below are meant to give you a basic understanding of the differences between entities, but you should check with your local government to see which type of business designation is right for your new venture.

Sole Proprietorships

Most small businesses choose the legal business entity of a “sole proprietorship”, where one person is the only “owner” of the business. Legally, there is no difference between you and your business, and while this business entity type is preferred by some because of the ease in setting it up and registering it, there is a greater legal risk assumed by the owner of a sole proprietorship. For example, if someone sues your business for infringement or fraud, they will be suing you, and your personal assets will be on the line if the case is taken to court – a disadvantage to this kind of legal business entity. This type of situation is rare to be sure, but from a business standpoint, it has the potential to be a risky move.

An advantage of this entity is the fact that you’re the only owner! You can make your own business decisions without having to consider the opinions of a board of directors, or other stakeholders. You receive 100% of the income from your business, and are free to file your profit on your individual tax return at the end of the year – a huge advantage to choosing this legal business entity type.

Partnerships

As the name implies, a partnership is an entity in which two or more people own a business together. Just like a sole proprietorship, there is no legal difference between the owners / members of a partnership and the business itself. As previously stated, choosing this legal business entity can have potentially negative consequences if someone were to file a suit against you or your business. An entity type of this sort carries an additional risk because of the added element of another person. For example, let’s say your business partner did something illegal and the court has decided to penalize your business assets because of his or her mistake. Although you have done nothing wrong, the whole business may be at risk of going under because of the partnership liability. Again, although this is rare, it is important to consider when choosing this kind of legal business entity. Types of considerations like this can protect your investment in the long run.

Speaking of investment, an advantage to a partnership is the ability to raise more funds with the influence of more people. Instead of having to shoulder all of the capital upon startup yourself, a partnership can help business owners divide the cost of operational expenses. And of course, because you’re sharing costs, you and your partner(s) will have to share profits as well. A benefit of this kind of legal business entity is the financial ease achieved by being able to file your profits under your individual tax return at the end of the year.

When starting a partnership, it is important to draw up a legal agreement detailing how costs and profits will be shared, what to do in the event of a partner wanting to leave the business, how to settle disputes about business strategy, etc.

Corporations

Unlike sole proprietorships and partnerships, where the owners are legally the same as their business, corporations offer business owners a unique legal and tax benefit in the sense that corporations are granted their own legal status. Therefore, this business entity type is considered as a separate legal business entity from you, your partners, and your shareholders. If your business were to be sued, it would not put you or your personal assets at any risk. So wait…who are shareholders? Whereas you’re an owner / operator / member of your sole proprietorship or partnership, you become a shareholder in a corporation, because this type of business operates with stock, or partial ownership distributed amongst several people. As a shareholder, you “own” a part of the business, but you also have to routinely answer to a board of directors who steer the direction of the company.

The downside to the legal business entity of a corporation is that you have less individual freedom to make executive business decisions, and you are not in total ownership of your business. This business entity type is more difficult to begin and dissolve, and often must comply with a series of complex federal and state regulations and taxes. However, the obvious benefit to this type of legal business entity is that you have more individual legal protection with the separation of yourself from your business in the event of a lawsuit.

Limited Liability Company (LLC)

Finally, a Limited Liability Company (LLC) is a sort of combination of all of the above business structures. Like the “corporation” business entity type, an LLC offers a legal distinction between a person and their company, but like a sole proprietorship or partnership, it offers the owner or member (we’re back to being called members now) control over business decisions, tax breaks, and offers no stock option. There is no limit to how many members an LLC may have, and it is also possible to just have one member. The obvious upside to this type of legal business entity is that it provides the best parts of both worlds, corporation and non-corporation, but the downside is that it is more difficult to file than a partnership (but is still less difficult than forming a corporation). To date, the federal government does not recognize an LLC as a classification when you file your federal taxes, so you must file either as a sole proprietorship, partnership, or corporation.

So What do I do Now?

As with any kind of legal decision, deciding which business entity type is right for your business is a big decision that requires a lot of thought. This is just an overview of the primary differences between each major legal business entity, so before making a decision, check with your lawyer or accountant to decide which is best for your financial and business interests. It seems complicated at first, but once you get registered with the state, you’ll be on your way toward owning and operating your own business!