1.3 Workbook

Getting Started

To properly organize your business, you need to address several important issues. First, you need to choose the name of your business. Second, you need to secure the web domain name you will use. Third, you need to register your business in the state of your choice. Fourth, you need to acquire a federal Employer Identification Number (EIN). And finally, depending on the nature of your business and the state in which you register, you may need to obtain a business license. Let’s discuss each of these items.

Securing Your Business Name

If you become a sole proprietor or form a general partnership, you can use your personal name as your business name – no need to register a name with your state. However, if you form a Limited Liability Company (LLC) or a Corporation, you need a business name before you can register your new venture. Even if you are a sole proprietorship or a partnership, we recommend you choose a name for your business and register for a DBA with your state (“Doing Business As”). A business name enhances your credibility with customers, suppliers, banks, landlords, and everyone else with whom you do business. Most states have a business website where you can register a DBA for a small fee.

If you form an LLC or a corporation, you will secure your business name when you register your company – no need to secure a separate DBA unless you want to do business under a different name than your company name. The U.S. Small Business Administration has an excellent website that reviews the requirements for obtaining a DBA and registering a business name in all 50 states. Visit this site for more information on securing a business name:

http://www.sba.gov/content/register-your-fictitious-or-doing-business-dba-name/

Securing Your Domain Name

Before securing your business name and registering your company, you need to make sure you can get the web domain name for your business. In today’s information economy, most people gather information about businesses through company websites. So a domain name is just as important – if not more important – than the physical address for your business. A great website can promote your brand, highlight your products and services, and entice customers to do business with your company. Without a website, you lack credibility in the marketplace.

Having a web presence is so important that we suggest you get the web domain name first, and then confirm that the name is also available in the state in which you will register your business. Companies that register web addresses are known as domain registrars. Here are several that allow you to search for names and then register the domain name of your choice: www.register.com; www.domain.com; www.godaddy.com

Once you secure your domain name and build your website, you need to obtain hosting services. Web hosting providers vary with regard to price, features, bandwidth, storage space, ease of use, customer services, etc. Here are websites that evaluate and rank top web hosting companies:

http://www.consumer-rankings.com/hosting

http://www.hosting-review.com/?gclid=CMLPv-jwoLECFcUZQgode3AbYA

Registering Your Business

You do not need to register your business in your state if you are a sole proprietorship or a general partnership – you are in business as soon as you start selling goods or services. For all other business entities you need to register or incorporate in a state of your choice. States vary widely with regard to registration fees, time for approval, renewal fees, income taxes, etc. Most business owners register in the state where they reside and where their company office is located. This is called “Home State Incorporation.” However, it is possible to register your business in another state if you feel the fees and regulations are more attractive. In this case you obtain what is called “Foreign Qualification” and receive a “Certificate of Authority” from that state. It is always best to consult an attorney if you want to register your business in a state other than your home state. The U.S. Small Business Administration has a helpful site on the requirements for registering a business in any of the 50 states. Visit it for more information:

http://www.sba.gov/content/registering-your-business-state-agencies

Based on the state in which you register, you will apply with the Department of Commerce, Division of Corporations, Secretary of State or some other state office. The basic information you will provide will include your company name, address, business purpose, and registered agent (the person who will receive all correspondence from the state). If you are forming a Limited Liability Company you will also provide the names of all owners and the management structure of your company. If you are a corporation (either S or C) you will provide the number of authorized shares of stock, the par value per share, the directors of the company, and the officers responsible for day-to-day operations. All of this information will become a matter of public record.

Obtaining A Business License

States require different kinds of licenses for different types of businesses. For example, there are special licenses for contractors, plumbers, doctors, dentists, food businesses, factories, etc. Each license has its own set of requirements and may include exams, certifications, insurance and fees. State and local governments monitor these types of businesses to ensure the public safety. Until you have the proper license you cannot conduct business, open bank accounts, obtain bank loans, and acquired other services you may need to grow your company. Always check with your state of registration to determine what type of license you may need to legally operate your business. Here is the link to the U.S. Small Business Administration site that shows what licenses are required for different types of businesses in the various states:

http://www.sba.gov/content/business-licenses-and-permits

Obtaining an Employer Identification Number

An Employer Identification Number or EIN is a nine-digit number issued by the Internal Revenue Service that is used for tax filing and other business purposes. You need an EIN when you start a new business, open a bank account, hire employees, withhold taxes, etc. Your EIN is like a social security number for your business. If will be a permanent identifier with the IRS as long as you operate your company. To obtain an EIN you need to complete and submit “Form SS-4” to the IRS. You can easily do this online or by phone. Here is the link to the IRS for obtaining your EIN:

http://www.irs.gov/businesses/small/article/0,,id=97872,00.html

Forming Your Entity

You have a number of business formats or “entities” to choose from when forming your new venture. The entity you select will depend on a number of factors. Some of the more important issues to consider are: How many owners will you have? What kinds of owners will you have? What liability protection do you want for your owners? What type of tax structure do you prefer? How much capital will you raise over time? What is the long-term goal for your business? What is your exit strategy? Here are the most common types of business entities available.

Sole Proprietorship

A Sole Proprietorship is the simplest business format. It is not an actual legal entity; it is you doing business as yourself. Once you start selling goods or services you have automatically created a Sole Proprietorship. The advantages of a Sole Proprietorship are (1) you can begin selling products or services immediately, (2) you do not need to register with the state, (3) you have no registration, license or filing fees, (4) you do not need to file a separate tax return for your business, (5) you can make important decisions and changes quickly, and (6) there are fewer formalities required in operating your company.

Here is the huge downside to a Sole Proprietorship. Since you are not a legal entity, your personal assets and your business obligations are one in the same. If your company accumulates a large amount of debt or a lawsuit is filed against you, all of your personal assets are exposed to meet these obligations: your home, home furnishings, cars, real estate, personal bank accounts, stock holdings, etc. In other words, if your business fails, you can lose everything you own. In addition, since you are the only owner, your business dissolves with disability or death. Most attorneys will advise against a Sole Proprietorship if you have significant assets and want to build a serious business over time that has value beyond your own effort.

General Partnership

A General Partnership is similar to a Sole Proprietorship, but two or more people have agreed to do business together. A General Partnership can start with a simple handshake, and commence operation as soon as goods and services are sold. Like Sole Proprietorships, General Partnerships are not required to register with the state, do not pay filing or license fees, and require fewer management formalities than other business formats. For tax purposes, a General Partnership is a “Pass Through” entity, which means profits and losses are passed on to the partners, and each partner pays taxes at his or her own personal income tax rate. The partnership does not file a tax return or pay taxes as a business entity.

Despite these advantages, General Partnerships have the same downside as Sole Proprietorships: personal assets and business obligations are one in the same. While any single partner can bind the business to legal contracts, all partners are personally liable for debts and court judgments. Most concerning is the fact that any given partner can be sued for the total amount of all business liabilities. This is why opposing attorneys often go after the partner with the “deepest pockets” in legal disputes. So your partner can bind the business to contracts, but you can be responsible for those obligations. For this reason, most attorneys do not recommend General Partnerships. When they are used, it is important for the parties to create a clear written agreement that defines roles, responsibilities, decision making authority, and rules for binding the company to financial obligations.

Several other types of partnerships should be mentioned briefly. A Limited Partnership (LP) has two classes of partners: general and limited. The general partner runs the business and bears all the liabilities. Limited partners contribute capital and share in the profits, but do not manage the business and are not responsible for debts – their only risk is the capital they invest. Also, a Limited Liability Partnership (LLP) is often used by professionals: doctors, accountants, architects, etc. All partners participate in management and are liable for their own actions, but not the actions of their partners. Both of these partnerships are “Pass Through” entities. The earnings are passed on to the partners, and the partners pay taxes at their own personal income tax rates. Here is a website that has excellent information on the various types of partnerships:

http://www.nolo.com/legal-encyclopedia/limited-partnerships-limited-liability-partnerships-29748.html

C Corporation

A C Corporation is a legal entity that exists apart from its owners or shareholders. As a separate entity, it has rights privileges and liabilities of its own. To form a C Corporation you must file “Articles of Incorporation” with the state of your choice and pay the required fee. You must also create bylaws, hold an initial meeting with directors and shareholders, and issue shares of stock to your owners. The C Corporation is the required business format for publicly traded companies, and the most common format for large private organizations. It is also the preferred business structure for venture capitalists. Here are the unique characteristics of the C Corporation:

• It is a stock bearing company which makes it easy to raise capital
• There is no limit to the number of stockholders or types of owners
• It is easy for owners to sell their shares if they want to exit the company
• Individual shareholders are not responsible for company liabilities
• The business is managed by a formal board of directors
• Executive officers who report to the board run the day-to-day operation
• The corporation files a tax return and pays taxes on its profits as an entity
• Shareholders pay taxes on the dividends they receive from the corporation
• The entity has unlimited life beyond any founders, board members or shareholders

Double taxation is the main downside of C Corporations. The entity pays taxes on its profits, and shareholders pay taxes on the dividends they receive. In the U.S. with a corporate tax rate of 35 percent, state tax rates as high as 12 percent, and personal tax rates of 35 percent, most of the earnings from large corporations in the United States go to various government entities. The next type of business entity – the S Corporation – helps reduce this tax burden.

S Corporation

The S Corporation is actually a C Corporation that has been given a special tax status by the Internal Revenue Service. After incorporating, the business submits Form 2553 to the IRS to obtain this special status. S Corporations enjoy most of the benefits of the C Corporation, but do not pay taxes as a business entity. They become a “Pass Through” organization where profits and losses are passed on the stockholders who declare these earnings or losses on their own personal tax returns – thus, there is only one level of taxation.

In exchange for this special tax status, the IRS places some restrictions on the number and types of stockholders allowed in the corporation. For example, an S Corporation can only have 100 owners, and these owners all have to be individual U.S. citizens. Unlike C Corporations, other types of business entities cannot hold stock in S Corporations.

Limited Liability Company

A Limited Liability Company (LLC) is a hybrid organization – it combines the more attractive features of partnerships and corporations. From a management and tax perspective it functions like a partnership; from a risk and liability perspective it functions more like a corporation. Here are the important characteristics of LLCs:

• They have membership units rather than stock
• There is no limit to the number or types of members
• It is relatively easy to add new members to the company
• The personal assets of the owners are protected
• The company is not taxed at the entity level
• Profits and losses are passed through to the members
• Members can manage the LLC or appoint a manager

In sum, LLCs are very flexible with regard to ownership and management structure. They also offer attractive tax advantages and liability protection to their members. For these reasons, LLCs have become extremely popular in recent years and are becoming the entity of choice for many entrepreneurs.

To form an LLC you have to file “Articles of Organization” with your state. This can be done online in most states. In addition, you need to create an “Operating Agreement,” which is not filed with the state. This document clarifies who will be involved in the company, how the business will be managed, how decisions will be made, how money will be spent, etc. We strongly recommend you have an attorney help you with your operating agreement.

Nonprofit Corporation

A nonprofit corporation is an organization formed for some purpose other than making money. Nonprofits address a broad range of social issues including poverty, literacy, education, science, housing, aging, the arts, the environment, and so forth. Registering a nonprofit organization is similar to forming a corporation. You file “Articles of Incorporation” with your state, and then submit Form 1023 to the IRS to gain federal tax-exempt status. Some states require you to also file for state-level tax exempt status. In addition, to ensure that donations people make to your organization are tax-deductible, you need to become a 501(c) (3) nonprofit. If you plan on raising large amounts of money, this step will be critical to your donors.

After receiving tax-exempt status, operating a nonprofit organization is similar to running a for-profit corporation. You have a board of directors and an executive team that runs the organization. While you can compensate your executives at reasonable levels for services rendered, you cannot have shareholders or pay dividends. Any income or cash flow above your costs must be reinvested in the organization. Here is more information on forming a nonprofit corporation:

http://www.nolo.com/products/how-to-form-a-nonprofit-corporation-NNP.html

Comparison of Business Entities

Here is a Table that summarizes the for-profit entities we just discussed above. They are listed from the least restrictive regarding government regulations (Sole Proprietorship) to the most restrictive regarding government requirements (C Corporation).

When To Use Each Business Entity

There is not a “Best” type of business entity. Rather, the entity you choose depends on the kind of business you want to build and your goals for building your business. Here are some of the reasons you may choose one entity over another.

Selecting Your Business Entity

Selecting your final business entity involves tradeoffs. For example, you may want limited paperwork and operating formalities, but you also want to protect all your personal assets. Or you may want to avoid double taxation, but you also want to raise venture capital and take your company public. In the end, you have to decide which business format best meets your objectives for starting the company. If the future of your business is unclear, you can always start as a sole proprietorship, transition to an LLC, and then become a corporation. Just be aware that it is easier to transition “forward” along the way (Sole Proprietorship to LLC), than it is to go “backwards” (Corporation to LLC).

After answering the questions below, decide which entity you will use for your new venture and explain the reasons why. Get legal advice if you are serious about building this business. Good luck making your decision.