Fred Dunayer: Welcome to the SCORE small business success podcast, Been There, Done That. To get free mentoring services as well as to see the wide variety of resources available for small business, visit our website at www.score.org or call 1-800-634-0245. Now, here’s your host, Dennis Zink.
Dennis Zink: Episode Number 33; Business Incorporation 101. Fred Dunayer joins me today in our studio as co-host, SCORE mentor, and our audio engineer. Good morning, Fred.
Fred Dunayer: Good morning, Dennis.
Dennis Zink: Our guest today is Nellie Akalp with corpnet.com. Welcome to Been There, Done That, Nellie.
Nellie Akalp: Thank you for having me, gentleman.
Dennis Zink: Nellie Akalp is an entrepreneur, small business advocate, speaker, and author. Her first business was acquired by Intuit in 2005 and today she is the founder and CEO of corpnet.com which is an online legal document filing service that helps entrepreneurs start, grow, and maintain their business. Nellie contributes her expert advice to Forbes, Entrepreneur, Huffington Post, and now Been There, Done That. She frequently speaks at small business expos and has appeared as a guest on the Fox Small Business Network. Again, welcome to our show.
Nellie Akalp: Thank you for having me.
Dennis Zink: Nellie, why is incorporating a business important?
Nellie Akalp: For most new entrepreneurs the process of incorporating or forming an LLC is really an unfamiliar road to navigate. The bottom line is incorporating your business is important for several reasons. Liability personal asset protection is the main reason because without incorporation your own personal savings and property are at risk to settle any debts of the business. God forbid, the business should get sued or wrong somebody. In addition to liability and personal asset protection there are tax benefits. Liability protection is the key benefit for incorporating or forming an LLC but in some cases forming a corporation can help you lower your overall tax burden. Corporations and LLCs often qualify for additional tax benefits and deductions that aren’t normally available to individuals.
Other benefits include added layer of privacy. When you incorporate or form an LLC, there’s an added layer of privacy. In many cases, a registered agent, which a corporation or LLC must designate for the corporation goes on record leaving your home or business address private so that nobody can get access to you. Last but not least, venture capital funding. A corporation offers a known stock structure with really transferable shares so in most cases, when you incorporate you can have, as a corporation or an LLC it could be easier to access a line of business credit or seek venture capital funding. That’s really in a nutshell the benefits of why you need to incorporate and why incorporation is so important to a business.
Dennis Zink: At some point, once you’ve incorporated does it make sense to either change the structure or let me ask it backwards. Does it pay to start as an LLC and then look at a corporate structure if you’re thinking of going public or raising funds?
Nellie Akalp: That’s a great question. Often times as a small business owner the two most frequently-used business structures are either the S corporation or the limited liability company. In answer to your question, you can always convert from one structure to another structure, such as if you’re an S-Corp and you want to convert to a C-Corporation, which is the most attractive type of business structure. If you have an exit plan or if you want to seek venture capital funding down the line, or vice versa; if you’re a corporation and want to convert to an LLC you can do that. Again, it really depends on the nature of your business and what stage of the business you’re at, what stage of growth you’re at. In answer to your question, again, at any given point in time, and as long as your state offers this filing, you can always convert from one business structure to another.
Dennis Zink: What types of personal assets can incorporating protect?
Nellie Akalp: Any type of personal asset that you own as an individual is protected if you incorporate or set yourself up as LLC. As a corporation or an LLC what is happening is that you’re creating this corporate shield, this bubble around you as an individual so that nobody can get to your personal assets ranging from your car, your house, your personal checking account, your savings account, your retirement account, your children’s savings account. Keep in mind, it also protects you against any future acquired assets too. When you incorporate or form an LLC you’re protected not only against your current assets but also against your future acquired assets. In a nutshell, anything that you own individually as an asset and you outright own rights to it can be protected if you incorporate or form an LLC.
Dennis Zink: Nellie, what are the most popular business structures?
Nellie Akalp: The sole proprietorship is the simplest form of business entity. However, without the protection of a corporate shield, again, personal assets are exposed to business liabilities. Even where a small business owner doesn’t have assets today, a judgment against that business owner can last up to 22 years so the sole proprietorship is one form. Again, with a sole proprietorship it’s basically one entrepreneur, one small business owner doing business under their own name or under a fictitious business name by filing what is called a Doing Business As filing or registration with their state or county clerk’s office. The next type of business structure is a partnership. Again, with a partnership it’s like a sole proprietorship but it’s two or more people doing business together under their own names or under a fictitious business name or Doing Business As filing. Just like the sole proprietorship, the partnership offers no personal protection, there is no liability protection.
All the assets of a sole proprietor or a partnership, ie. the partners within a partnership, are exposed to business liabilities and there is no protection of a corporate shield with these two types of business structures. Then what we get into is the types of business structures that offer you liability protection and we start out with the corporation, which there’s two types. There’s the C-corporation and the S-corporation. With the C-corporation this entity is not recommended for small business owners. The C-corporation is ideal for a business that intends to raise capital by issuing stock or attracting investors through VC funding. Again, a C-corporation is your formal corporation whereby you have your shareholders, your directors, your officers, and you’re getting taxed once at the corporate level when the corporation reports profits. Then when the corporation makes a distribution out to its shareholders, the shareholders get taxed again on their individual tax return.
With the C-corporation it’s the most formal type of business structure out there. It offers you the liability protection, taxes, credibility, added layer of privacy, everything we covered under why you want to incorporate and the benefits. However, again, this entity is not recommended or ideal for a small business owner. At which point we want to talk about the S-corporation which is great for a small business owner. The S-corporation, again, it starts out as a C-corporation because it is a corporation but for those business owners who can qualify with the IRS you can make an election to be treated as an S-corporation for tax purposes. With the S-corporation, again, it’s great for a small business owner who can qualify. The IRS places limits on the number of owners and who can be an owner in an S-corporation because with the S-corporation you have to be a citizen or resident of the U.S. You can only have up to 100 shareholders within the S-corporation and you can only have one class of stock.
However, it’s great for a small business owner who can meet these requirements, plus all owners if you qualify, are tax based on their percentage of ownership. With an S-corporation the greatest benefit is that as a small business owner you’re not only getting the benefit and liability protection of the C-corporation and what it offers you, however, you’re getting the benefit of not paying double taxation. There’s this feature of double taxation avoidance with the S-corporation in that all the profit and losses that are distributed among the shareholders of the corporation are only reported once on the shareholders individual return. Thereby with the S-corporation it’s great for a small business who doesn’t want to pay the double taxes, wants that liability protection, and also is interested, as a shareholder, to list themselves on payroll for that corporation.
Dennis Zink: There’s a lot there.
Nellie Akalp: There is a lot; there is a lot. Frankly we can go through and spend literally an hour on just the different types of business structures and get into it much deeper. For the purposes of this podcast I want to move over to the LLC which is the other type of business structure that we’ll cover for a small business owner. The LLC stands for a limited liability company and, frankly, how I like to describe the LLC is for a small business owner, they get to have their cake and eat it too. It offers all the benefits that a corporation would offer you but without all the formalities. It is ideal and great for a business that wants that liability protection but seeks minimal formality. The only document that controls the LLC and binds the members of the LLC together is called and referred to as an operating agreement. It’s really great for that small business owner who wants that liability protection, that peace of mind, the credibility, the tax advantages, establishing that business credit and capital, that added layer of privacy, but really doesn’t want to deal with all the headache involved and all the paperwork and formalities that are often required by a corporation or an S-corporation.
It’s also perfect for a business with foreign owners because in an LLC, anyone can be an owner of an LLC. You can have C-corp as a member of an LLC, an S-corp, another LLC, a trust, a foreigner, an estate. The LLC really is a hybrid between a corporation and an S-corporation because not only it’s great for a small business because of the liability protection it offers, because of the minimal formalities. In addition to all of this, just like the S-corporation it offers that pass-through tax feature whereby you’re not doubly-taxed. We refer to it as double taxation avoidance. Just like the S-corporation the LLC offers this feature as well and for those of you who are considering whether to go LLC versus S-corporation we recommend you consult your tax advisor and see which entity will provide you with the maximum tax advantages and what’s best for your particular business.
Dennis Zink: Nellie in certain states that, for example, Florida, I know there’s an issue with LLCs having one member as opposed to multiple members in terms of legal issues, can you comment on that?
Nellie Akalp: From my knowledge in the State of Florida you can have a one-member LLC. However, I think what you’re referring to is the way they’re taxed. As a single-member LLC, you would be referred to as a disregarded entity or you can be taxed as an S-corporation, but there is no bar or any requirements within the State of Florida that prevent a single member LLC from being formed. I happen to know that because Florida is one of our top states for forming businesses for our clients and LLCs happen to be very prevalent as far as the type of business structure we form in the State of Florida.
Dennis Zink: No, I was talking from a legal perspective because Florida courts have found that a single-member LLC is subject to piercing more than if you have 2 or more members. Are you area of that? Maybe you’re not aware of that in Florida because I know you’re not in Florida.
Nellie Akalp: NO, I actually I’m aware of it but, again, for us it’s a matter of we look at it from a general standpoint in that you can have piercing of the corporate veil for any type of entity. Obviously, in the State of Florida and specifically with one-person corporations and LLCs there’s this default that the courts will look at you and really question as to what is the specific purpose of you setting this corporation or LLC up. Are you trying to hide the assets or are you really doing it for conducting a lawful business? I think where you’re coming from is the fact that there’s this default or raising of the eyebrows, I should say, when it comes to the courts. Looking at small business owners and really why the purpose is that they’re setting it up as a one-man show, as a corporation or an LLC, versus just conducting the business as a sole proprietor.
Dennis Zink: Nellie, as you went through the litany of the different types of structures, I had several questions and jotted down a few notes. I’d like to go back a minute to sole proprietorships for just a second. Obviously, that’s not the best form of entity for most business choices. However, you can protect a sole proprietorship with an insurance if you have insurance to protect against liability. Can you comment on that?
Nellie Akalp: Great question, great comment, absolutely. As a sole proprietor there are definitely business insurance policies out there for you that can protect you as a sole proprietor. Again, in light of how easy and inexpensive it is these days to set up yourself as a corporation or an LLC I think it really behooves a business owner from not considering going that route. Especially if from the get go their business is taking off and is profitable.
Dennis Zink: Can you comment on the best places to set up these entities as far as the different states?
Nellie Akalp: The general rule of thumb is you want to set up the corporation or the LLC in the state where your business has a physical presence. Physical presence can be the state where your business is physically located, where any property is owned by the business, is located, where your employees reside, where the shareholders reside. I know that there’s this hype and you’ve probably seen that many companies choose to incorporate in Delaware or Nevada. There’s a good reason why these two states are hot choices for incorporation. Delaware offers very developed, flexible, and pro-business statutes, while Nevada has low filing fees and no state corporate income franchise or personal income taxes. However, again, these states aren’t for everybody. If your corporation or LLC will have less than 5 shareholders or members it’s best to incorporate or form the LLC in the state where your business has physical presence.
Dennis Zink: Nellie, at what stage should a company decide to choose the different structures and when should they change? Based on when they form their organization or if they’re thinking of selling or if they take on additional partners, can you comment on that please?
Nellie Akalp: Again, the default is that most small businesses consider themselves too small to worry about incorporation. However, in my opinion whether you’re a self-employed social media consultant, a landscaper, a cleaning service, or a PR consultant, incorporating or forming an LLC is a smart idea. Again, in my opinion you should consider incorporating yourself or forming your LLC the sooner rather than later. As we discussed earlier if the business is launching and it’s going to be profitable from the get-go, it’s a wise idea to consider setting yourself up as a corporation or an LLC. In answer to your question as to the small business owner is decided they want to incorporate and they’re ready, “What form of business structure should I form from the get-go?”
Again, it really depends on what type of business they’re conducting and how much formalities are they willing to take on as a small business owner. In addition, which type of entity between the LLC and the S-corporation will offer them the best tax advantages? If they’re a single business owner and they want that liability protection and they don’t want all the formalities and they don’t have a problem with paying self-employment taxes and being a member of an LLC versus being an employee, then the LLC is ideal for that small business owner. If the business owner is in a relationship, they’re married, and the husband and wife are conducting the business together and they want to become employees of the corporation and they don’t mind the minimal formalities afforded with that S-corporation, and they don’t want to pay self-employment taxes, then the S-corporation is ideal as long as they can qualify.
Here at CorpNet we have a great tool that’s right off our homepage of our website. It’s called The Business Structure Wizard and it was created by attorneys and accountants; which is great for a small business owner who is considering taking on the incorporation process but really doesn’t know what business structure is best for them. This Wizard will take you through a 3-minute questionnaire and will ask questions from the business owner and lead them through a process and a survey. At the end of this interview it will recommend which business structure is right for your small business. We definitely recommend any of you that are considering taking that next step of incorporating your business to take a look at the Business Structure Wizard offered by CorpNet to see which business structure is right for your business and will offer you the maximum tax benefits for your small business.
Fred Dunayer: Nellie, are there any special considerations if you’re planning on doing a web only business?
Nellie Akalp: Again, I’ll use our company as an example. We’re a national website; we’re a legal document filing service. We offer our services in all 50 states, and frankly, we’re and S-corporation, so in answer to your question, no. Again, that goes for what type of business structure you’re trying to form in addition to where you’re trying to set up the business structure. It really depends on how you’re conducting the business and how you want to be taxed as the business owners involved within the corporation or the LLC. In our case, we elected to be an S-corporation because both of us are very active within the business and we’re employees of the business.
As an S-corporation the shareholders of the corporation can be employees of the corporation; whereas, with an LLC that’s not the case. The members of the LLC cannot be employees of the LLC and are subject to only take a draw and you have to pay self-employment taxes on that draw. In answer to your question it really depends on the individual business owners’ financial status, and how they want to be taxed as individuals, and whether they want to be employees of their company, and how involved they are within their company.
Dennis Zink: Are there any other filings business owners need to make to stay on top of compliance and good standing in their states?
Nellie Akalp: Absolutely, so the hype is that once I incorporate my business my job is done and that’s not the case. When you incorporate or form an LLC, most states will require you to file a yearly statement of information. We refer to it as an annual report with the state to make sure the state has up-to-date information on the corporation or LLC. Yes, there are flings that need to be complied with in order to keep the business in compliance and in good standing with your state for years to come and long as the LLC or corporation is active. Failure to do so will cause the LLC or corporation to go into bad standing. As a result you can lose that liability protection and that corporate shield around yourself and the business. Definitely consider checking in with your state after you’ve set up yourself as a corporation or an LLC to see what types of compliance filings are required to keep the corporation or LLC in good standing.
Again, throughout the year, as well, if you’ve changed business address you need to make sure the state has your updated business address on record. If you’re making changes to the structure of the corporation or the LLC such as adding someone in, deleting someone out, you definitely want to file what is called amendment documents with your state that you’re filed with to make sure the state has record of any changes your corporation or LLC has made. In addition, for your particular business type, once you’ve set up the business structure, you have to check with your state, and county, and local authorities to make sure that you have the proper licenses and permits to be able to conduct your business. Again, this is one area where small business owners fail to educate themselves on.
It’s like owning a house. When you build a house you’re setting up the foundation of the house. Once the house is built you have to get a certificate of occupancy to be able to occupy the house. Same with a business. When you start the business, you have to set up the foundation of the business first by setting the structure up such as a sole prop, partnership, corporation, LLC. Then once that business structure, that foundation, is set up you have to make sure you find out what type of licenses and permits you need to be able to legally operate that business so that you’re not, down the line, liable for any fines or penalties. You can ultimately get shut down if you don’t have the proper business licenses and permits for your particular business.
Fred Dunayer: Nellie, is there anything that we did not cover in this discussion or something you want to briefly reemphasize for the benefits of our listeners?
Nellie Akalp: I think the only thing that often times a business owner will ask is, “Okay, I now understand why I need to incorporate. I understand the benefits. I understand what state I need to incorporate in. Now how do I incorporate?” I think it’s important to know that the process to incorporate or form an LLC is relatively easy these days. There are three common methods and each has its own set of pros and cons depending on your specific situation. The first way, first method, is to do it yourself. With this method you will need to download or request the forms from your secretary of state’s office and submit the forms on your own. We call it do it yourself method. Obviously, the DIY method is the lowest cost method. You’ll still have to pay the state filing fee, the amounts vary by state.
For example in the State of Florida I believe it’s $78.75 to form a corporation and a little bit higher to form an LLC. If you’re more concerned about saving money than time and have a high tolerance for following the tiniest of details, this is a good option for you. Another method would be using a reputable online legal filing service such as our company. An online legal filing service will file the documentation for you. This option is slightly more expensive than filing yourself, yet for some the time savings and peace of mind are invaluable. We’ll do all the hassle, the paper filing, so that you can have the peace of mind to focus on what’s important; which is starting and growing your business and focusing on hitting those sales numbers. A professional online service will know exactly what is needed, what to file, and how to get it filed right and save you time and money.
Last but not least, it’s the attorney option. If you have particular complex business needs. For example, you have strict requirements for shareholder structure or stock allocation and you’re dealing with millions of dollars up front, then you should obviously consider retaining an attorney or your own expert counsel to help you get you started.
Dennis Zink: Nellie, thank you for being a guest today on Been There, Done That, and enlightening our listeners on Incorporating 101.
Nellie Akalp: It’s my pleasure, thank you for having me.
Fred Dunayer: Thank you, Nellie.
Fred Dunayer: You’ve been listening to the SCORE small business success podcast, Been There, Done That. The opinions of the hosts and guests are theirs and do not necessarily reflect those of SCORE. If you would like to hear more podcasts, get a free mentor, view a transcript of this podcast, or would like more information about the services we provide, you can call SCORE at 800-634-0245, or visit our website at www.score.org. Again, that’s 800-634-0245, or visit the website at www.score.org.