During the initial months of the year, savvy entrepreneurs rush to incorporate their businesses. And with good reason, a corporation or LLC is essential to protecting one's personal assets from any liability of the company. After all, if you're sued as a sole proprietor or partnership, you're sued personally - and that puts your personal savings and investments at risk.
Forming an LLC or corporation is a relatively quick and painless process. However, while it may seem straightforward, there are some common mistakes that business owners make that can have a significant impact on their business:
1. Choosing the Wrong Business Entity
Your choice in business entities will shape the amount of taxes you pay and paperwork you contend with. It's an important decision, one worth some research. The three most common types in the U.S. are the LLC (Limited Liability Company), S Corporation, and C Corporation. Here are a few things to keep in mind:
- The LLC is great for startups that want the liability protection, but prefer minimal formality and paperwork.
- The S Corporation is a pass-through entity for federal taxes (like the LLC). It should be used by startups that will make a profit soon after incorporation...and that profit will be distributed to the shareholders.
- The C Corporation files its own tax report. It should be selected by those startups who plan to reinvest profits back into the company or seek funding from a VC.
2. Incorporating in Delaware or Nevada
Delaware and Nevada are hot states for incorporation, and for good reason. Delaware offers some of the most developed, flexible, and pro-business statutes in the country. And Nevada is increasingly becoming a popular choice for businesses due to its low filing fees, as well as the lack of state corporate income, franchise, and personal income taxes.
However, if your startup has less than five shareholders, it's best to incorporate in the state where your business has a physical presence (i.e., where you live). Otherwise, you won't actually reap any of the benefits, and you'll be dealing with added hassles and costs of operating "out of state"Â including: difficulties opening a business bank account, having to appoint a registered agent, and fees for operating as a 'foreign entity' in your own state.
Hiring a Lawyer to File the Forms
You don't actually need to hire a lawyer to form an LLC or Corporation. If you've got a straightforward investment situation, you can use a legal document filing service to represent yourself to create a business entity. In the eyes of the law and IRS, your LLC or Corp will be just as valid than if a high-priced attorney sent in the documents for you.
Not Staying Compliant
Too many business owners think that their legal obligations are finished once their LLC or Corporation is formed. But, it's critical that you keep your LLC or Corporation in compliance. If a plaintiff shows that you have not maintained your LLC/corporation to the letter of the law, he or she can seek recovery against your personal assets. In short, the corporation's shield that protects your personal assets is pierced.
So, how do you make sure your corporation stays compliant? Keep your personal funds separate from those of the business (no commingling: this means keeping a separate bank account and credit card). Remember to send in your Annual Statement/Annual Report (if required by your state). And obviously, do not engage in any form of fraud.
By avoiding these common missteps, you can better protect your personal assets and minimize your personal liability, Of course, the biggest mistake of all is never forming an LLC or Corporation. So even if you're putting 80-hour weeks to find new clients or launch a new website, make some time this year to incorporate. By getting your legal ducks in a row early on, you'll be able to scale far more smoothly in years to come.