BUSINESS FORMATION BASICS


by Brad Davenport

Many people have the dream of starting their own business. While people often have great and novel ideas for a product or service, a business plan, and financing, it is equally important to understand the different forms of business entities that exist and consider which form is best suited for your goals and needs, what type of protection from personal liability, if any, each affords, and the corporate formalities to be followed to maintain the business in good standing.

A business may be operated as a corporation, limited liability company, or LLC, partnership, professional association, joint venture, or it may just be operated under a fictitious or “doing business as” name without establishing a formal business entity. The formal business entities like corporations and limited liability companies are formed by filing paperwork, either Articles of Incorporation (for a corporation) or Articles of Organization (for a limited liability company), along with a filing fee. In the paperwork filed with the Secretary of State, the owner or incorporator for the new company must provide the proposed name of the corporation or LLC, the principal place of business, and identify a “registered agent” for the business, who agrees to receive all legal papers, tax documents and official communications on behalf of the company. If all of the paperwork and information provided is in order, the Secretary of State will issue a Certificate of Incorporation, for example, to the new corporation.

The primary reason that most people forming a business should consider creating a formal business entity like a corporation or limited liability company is because those formal business entities are treated as a separate “person” from the individual owner or owners under the law. As a result, the separate legal status and treatment of the business entity limits the individual shareholder’s or member’s exposure to personal liability in most situations. On the other hand, a person who elects not to form a corporation or LLC, but just starts operating a business under a fictitious or “doing business as” name would have no protection from personal liability against a lawsuit or debt claim because the there is no separate “person” and the business and its owner are treated as one and the same. If you choose to establish a formal business entity, there are differences in how corporations versus limited liability companies are taxed, as well as other distinguishing features that should be discussed with your attorney and accountant to insure that the appropriate business entity is selected for you and your business.

Once you select and form a business entity, there are several basic corporate formalities, or rules, that must be followed to insure the continued recognition of the corporation or LLC by the State and to keep intact the protection from personal liability the entity provides. For example, one corporate formality that must be observed is for the corporation or LLC to maintain one or more bank accounts from which it operates that is completely separate from owners’ personal bank accounts. Another related formality is that company funds should not be used to pay personal expenses and personal funds should not be used to pay company expenses or bills. A corporate record book should be maintained that contains the company’s bylaws (for a corporation) or operating agreement (for a LLC), along with the Articles filed with the Secretary of State, the Certificate of Incorporation or Certificate of Limited Liability received from the Secretary of State, minutes of board meetings and shareholder meetings, and the company’s stock ledger or membership unit ledger. Contracts, loan documents, and even correspondence relating to your business should be signed by the appropriate officer of the corporation, with their title identified by their name and signature, such as “John Doe, President”, for example, or by “John Doe, Manager/Member” for an LLC. By observing these examples of corporate formalities and other applicable laws and regulations, one can enjoy the many benefits and protections that the formation of a formal business entity offers and help insure that an otherwise promising business endeavor does not falter or fail as a result of overlooking the importance of the formation and structure of the business itself.


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