As a result of the recession and the loss of millions of jobs nationwide, there has been a huge increase in new business start-ups over the past year. For many laid-off workers unable to find work, starting a business has been one way to gain employment.
When starting a business, itís important to start off on the right foot. And one of the first things you must do is to select the legal structure under which you will operate your business. Choosing the wrong corporate entity could cost you precious time, money and even risk your personal assets. So itís important to consult with an experienced attorney to come up with the best business structure for your specific situation.
Mark Alexander and Jim Coyle, attorneys with the Stewart Melvin & Frost law firm in Gainesville, Ga., help sort out this difficult business choice.
Question: For anyone starting a new business, you certainly have to watch your start-up expenses. But isnít it true that you could end up losing more money in the long run by not consulting with an attorney about how to set up your new business?
Mark: Itís not as easy as filling out an application from the Georgia Secretary of Stateís office. An entrepreneur typically is an expert on their particular business specialty, but they are not always as well-versed on the legal aspects of starting and running a business.
An attorney can assist with planning and guidance in selecting the proper corporate entity that best fits your business situation particularly from a tax and liability standpoint. In addition, there are certain corporate formalities Ė such as operating agreements and bylaws that must be followed in order to remain in compliance.
Question:What are the potential risks of choosing the wrong corporate entity for your new business?
Jim: One reason for setting up a corporate entity is protection of your personal assets. I recently had a client in the home construction business that faced a lot of debt due to the collapse of the housing industry. Fortunately, he was able to protect his personal assets such as his home and car due to the companyís corporate set-up. Creditors could claim the companyís corporate assets but they could not go beyond the veil of personal protection provided by the corporation.
On the other hand, if this home construction business had been set up as a Sole Proprietorship, the owner would have been personally liable for all claims against his business. The paperwork required for a Sole Proprietorship is minimal and very inexpensive, but it can cost you a whole lot more if youíre ever sued or the business fails.
Question: What are some of the other options?
Jim: Similarly, a business may choose to operate as a General Partnership, where each partner is responsible for the actions of the other. And like a Sole Proprietorship, personal assets may be at stake. There is no filing requirement for a General Partnership, so many businesses that started with nothing more than a handshake could be viewed by the courts as a General Partnership. Under a General Partnership, you are liable for your partnerís mistakes as well as your own mistakes if you should happen to be sued.
Business entities that provide more protection are: C Corporation; the S Corporation; the Limited Partnership (LP); and the Limited Liability Corporation.
These are separate legal entities with their own name and tax identity. The corporation is only responsible for the actions of the corporation, not the individual owners or shareholders. You are only liable for the money that you put into the company to get it started.
It is not enough to establish a corporate entity. You must follow certain corporate requirements to maintain your corporation status. Otherwise, a creditor may be able to claim that the business is a corporation in name only, which would allow the corporate veil to be pierced and personal assets claimed.
Another important advantage of establishing a corporate entity can be the tax advantages. For example, an S Corporation allows the owners of the corporation to receive a portion of their income in dividends, which are taxed at a lower tax rate than ordinary salary.