Jason* always wanted to own his own business. When he was young, he was always hatching a plan to sell something or provide a service so he could make money. He worked hard – important when starting your own business: Shoveling snow, raking leaves, mowing lawns, selling stationery…no job was too small or too dirty, as long as the dough rolled in and he was the boss.
In his early twenties after graduating high school, he worked in a large Midwest city selling program advertising for one of the world’s largest music festivals. He enjoyed the work, and found out he was really good at it. But that old instinct to be his own boss just wouldn’t go away. Jason was always looking for a way to start a business of his own that would grow and be successful.
He finally found it. Adventure travel and lifestyle sports were becoming all the rage in the Midwest, but there was no affordable vehicle for advertisers to communicate with consumers about their products and services in this area. Jason knew how to sell advertising. He loved adventure travel and lifestyle sports and was a true enthusiast in his own right. Creating a magazine that focused on this topic was a no-brainer for him; his excitement to begin selling ads and publishing it was off the charts.
Jason will tell you…starting your own business is the easiest thing in the world. In fact, in most states, it’s a matter of filing little to no paperwork at all. As long as you say you’re in business, you are. In Jason’s case, he figured out right away what he wanted to name his company and his publication. He did on-line searches and ran ads in the local paper to make certain no one else had the names he wanted. He filed all the paperwork to ensure those names were his and that no one would sue him for using them. He was a talented, driven and committed business owner who was sure he had covered his bases. What could go wrong? How could he fail?
In Jason’s case, the worst-case scenario was 9/11. When the terrorist attacks on New York City happened in 2001, Jason’s business was devastated. For hundreds of business owners, that was the day the bottom fell out. It wasn’t that Jason had been operating irresponsibly or too much in the red. Most magazines struggle at one time or another, especially around press time. Just so happens, Jason was days away from publishing the next issue on that fateful Tuesday. Dozens of clients who advertised most faithfully in his magazine were so adversely affected on that day that they stopped advertising and many went out of business altogether…virtually overnight. They couldn’t pay him; he was strapped in getting the magazine off press. So even though, as magazines go, Jason’s was considered successful, it just couldn’t survive. He had to close up shop, and fast, but it wasn’t that simple.
You see, way back when Jason was deciding how to structure his business, he took the least expensive and easiest route, one that thousands of business owners take each year. He chose to be a sole proprietor rather than creating an LLC (limited liability company), or even researching the option. It is a decision he has lived to regret. By choosing to be a sole proprietor and not spending the time and money to explore other options more fully, Jason put everything he had worked for both personally and professionally on the line. He’s a smart guy, but he didn’t know what he didn’t know. Seven long years later, he’s still paying for it.
Before you buy or begin the process of starting your own business, you have to do your homework. How you choose to structure it is perhaps the most important decision you will make as you get started. It truly does set the stage for everything that follows. Yes, gathering all the information about your options and making the final decision can seem complicated. But, finding an expert who is equipped to help you make the best one for your business and who can educate you about what the trade-offs might be later on is not as expensive as you might think when you consider the alternative. Take Jason’s word for it…it’s worth every penny. In fact, some resources are free. You just need to know where to find them. The most important thing to know is that you cannot afford to NOT make this decision carefully, and here’s why….
If you as a new business owner do not actively explore your options when it comes to structuring your company, you will, by default, become a sole proprietor, just like Jason. As a sole proprietor, you are personally liable in the event of a lawsuit of any kind. If your company can’t produce or make good on what it’s selling for any reason and you owe anyone money, they will be able to sue you personally for it, even if it means garnishing your wages well into the future.
For instance, let’s say you’ve purchased a laser printer for your business as a necessary investment to get the job done, but you financed it through a local retailer, and you go out of business tomorrow, even if it’s through no fault of your own. Suddenly, you find yourself unable to generate revenue, but you still have to pay for the printer, right? Okay, let’s say you can sell it…not for what you owe, that’s for sure. So, right there, you’re in trouble. Heck, even if you own the printer outright, but you owe someone else for something at the time, and you need to sell it to pay that bill, the printer’s not worth much now that it’s used. Now, if you set up your company as an LLC, when starting your own business, you most likely are not personally liable for your company’s debts should the unforeseen happen. An LLC does take some up-front investment and it takes more effort to sustain than a sole proprietorship, but can you afford NOT to choose that option if it’s available to you? No, you can’t, especially when you can set one up for not much more than you might have paid for that laser printer we talked about, and all states now allow one-owner LLCs.
Boiling this somewhat complex topic down in one article is next to impossible, but thankfully there are experts who can help you make this decision in a timely and cost-efficient manner.
Brian Liu is the co-founder and chairman of LegalZoom.com, one of the foremost on-line resources for legal services of all kinds. LegalZoom processes thousands of LLC applications for business owners every month. Needless to say, they are the experts.
Mr. Liu was kind enough to grant BusinessOpportunity.com an interview on the topic of LLCs and why any business owner needs to at least consider it, as well as all the other structuring options. Here’s what he had to say:
In simple terms, what exactly is an LLC and what benefits does it offer when starting your own business?
Like a corporation, a limited liability company or an LLC, is a separate and distinct legal entity. This means that an LLC can obtain a tax identification number, open a bank account and do business, all under its own name. The primary advantage of an LLC is that its owners, known as members, are not personally liable for the debts and liabilities of the LLC. For example, if an LLC is forced into bankruptcy, the members will not be required to make up the difference with their own money. If the assets of the LLC are not enough to cover the debts and liabilities, the creditors cannot look to the members, managers or officers for recovery.
What are the other structure options and how does the LLC compare?
The other options are sole proprietorship, partnerships (if there’s more than one owner) and corporations. Corporations are further divided into C-corporations and S-corporations. In general, an LLC combines the best from both partnerships and corporations.
In general, sole proprieties and partnerships offer the greatest level of flexibility and are the least expensive to start and maintain, but they don’t offer personal liability protection for their owners. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner’s personal bank account, house, etc. to make up the difference. An LLC is also extremely flexible, but if an LLC runs out of funds, the owners are usually not liable.
Corporations offer personal liability protection, but they must hold regular meetings of the board of directors and shareholders, keep written corporate minutes and file annual reports with the state. On the other hand, the owners and managers of an LLC do not need to hold regular meetings, which reduces complications and paperwork.
An LLC has maximum tax flexibility. It can be taxed either as a “pass-through” entity (like a sole proprietorship or partnership), as a regular C-corporation or even as an S-corporation. By default, an LLC is taxed as a pass-through entity, and the owners of the LLC are not subject to double taxation. This is different from a C-corporation, which pays a corporate tax on its net income (the first tax). Then, when the corporation distributes profits, the stockholders pay income tax on dividends (the second tax). With an LLC, the profits “pass through” to the owners who pay taxes at their individual tax rates. S-corporations can also be taxed as a pass-through entity and actually offer superior tax benefits compared to sole proprieties, but there are certain ownership restrictions with S-corporations.
If a new entrepreneur is trying his/her hand at owning a business, what advice would you give that person about how to structure his/her company? Why?
I would say, do as much research as you can first. LegalZoom offers a great education center where you can learn about the different types of entities, and we have a convenient comparison chart. Part of it also depends on the type of business that you try to start. For example, if you’re buying real estate, it should probably be with an LLC or S-corporation, but definitely NOT a C-corporation because of adverse tax consequences. Then, if you still need to speak to an accountant or lawyer, you’ll be in a much better position when starting your own business.
If a business owner does not want to create an LLC at the outset, can he/she create one at anytime? When will that person know the time is right?
You can do it anytime. In general, if you have personal assets you want to protect and you think there’s risk with the business, then you should definitely create an LLC or corporation. If the business is expanding and you want more credibility, if you want new options to compensate your employees, then that’s also a good time to consider an LLC.
From a legal perspective, what are some of the most common mistakes entrepreneurs make when setting up a small business? How can these pitfalls be avoided?
If they’re starting a corporation or LLC, it’s making sure that they complete the incorporation process. For example, you need an operating agreement with the LLC, and you need to adopt corporate bylaws with a corporation. Otherwise, you risk losing your personal liability protection. If you try to do it on your own, you may miss some of these things. LegalZoom’s packages include everything you need to start your business.
Setting up a separate business banking account is also extremely important, as well as keeping good accounting records. Use a separate accounting software program when starting your own business.
What resources are available to and should be utilized by business owners who want to set up an LLC? How does someone identify those resources as reputable?
There are many books on starting an LLC, as well as numerous companies online that can help you form an LLC. To determine if a source is reputable, it’s always good to know the people behind the company, as well as whether the company has a good track record with the public and the Better Business Bureau. For example, was the company started by attorneys? Do they have an “A” rating with the BBB?
What is the average cost associated with setting up an LLC?
An attorney will charge, on average, $2000 to form an LLC. At LegalZoom, our basic package starts at $149, plus state filing fees.
For more information, please see LegalZoom’s LLC Education Center at https://www.legalzoom.com/llc-guide/limited-liability-company.html.
*Jason’s name has been changed to protect his privacy.