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Starting a Business: Entity Selection

Several months ago I saw a commercial with a woman talking about starting her toffee business with her mother's secret recipe and incorporation documents from an internet site. You know the one. I like the commercial because it highlights her entrepreneurial spirit and her story, she took what she thought was a small idea and, with hard work, made a successful company, is always a good story to hear. But because you are what you do, I wondered if the internet site helped her decide on the type of entity to use for her business and whether it addressed potential liability and tax issues, ownership structure, minority owner issues, profit and loss allocation, and transferability of ownership interest. I suspect it did not

Start-up companies have many options when it comes to entity choice. It can operate as a partnership or a variation thereof. Partnerships generally receive favorable tax treatment. Or the owners could decide to incorporate and operate as a C-corporation or elect to be taxed as an S-corporation. A corporate structure generally provides the owners with protection from the company's liabilities. Increasingly, owners choose to operate as a limited liability company because that form allows for certain tax advantages, limits the owners' liabilities, and does not require all the formalities of a corporation.

There are several factors that influence the choice too, including the issues mentioned above. In short, the act of selecting an entity type is an exercise in evaluating the pros and cons of each entity type and selecting the one that matches best with the company's goals. Here are some of the issues to consider.

Tax benefits

A business generally receives more favorable tax treatment if it operates as an LLC or S-corporation. By choosing these entities, "double taxation" can be avoided. If you choose to operate as a C-corporation, income will be taxed twice: once at corporate level and then again when shareholders receive income in form of salaries, bonuses, or dividends.

Liability protection

Those who operate a sole proprietorship or partnership can find themselves in messy legal situations where their personal assets can be used to satisfy outstanding business debts or losses. The corporate or LLC form can limit a business owner's liability; in effect, it creates a wall between the liabilities of the business and the owner's assets.

Efficient capital funding

Raising capital as a sole proprietor or partnership often means taking a personal loan out to fund the business. A business operating as a corporation or LLC will borrow money in the company's name. A corporate form also typically provides a greater variety of potential investment structures, which may help the owners attract new investment as the company grows.

Increased credibility

In the eyes of consumers, incorporation can convey a sense of stability and seriousness. Having "LLC" or "Inc." at the end of the company name can speak volumes about the trustworthiness of your business.

If you need help in establishing your own business, the corporate attorneys at McBrayer, McGinnis, Leslie & Kirkland, PLLC, can help you understand the pros and cons of all business structures, including incorporation.

Thomas D. Flanigan is a member of McBrayer, McGinnis, Leslie & Kirkland, PLLC in the Lexington, KY office. Mr. Flanigan specializes in the areas of entrepreneurial business, lending and commercial services and mergers and acquisitions. He can be reached at tflanigan@mmlk.com or 859-231-8780.

This article does not constitute legal advice.

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