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The Key Decisions to Make when Forming a Company

The act of forming a company is, actually, easy. Fundamentally, it means filling out a few blanks in a form from the Secretary of State website and mailing in a check. Done. In fact, for a business with only one owner, other organizational steps like appointing officers, signing up an LLC agreement and printing certificates, may not even be necessary.

The harder part is making the key formation decisions, like what kind of legal entity to form, in what state to file and what tax elections to make. For questions like these, paying a website for a package of standard company documents won’t help at all. But spending thirty minutes with your lawyer and accountant will make all the difference. To give you a sense for what some of these decisions are, I’ve laid out a few thoughts.

The first question is likely to be what kind of legal entity you should form. When my father formed his small business in 1972, there was only one option if he wanted to benefit from limited liability: the traditional C Corporation. Today, there are limited partnerships, corporations, limited liability companies (LLCs) and so called Subchapter S corporations. They offer different things, but, for most small businesses, an LLC will be the preferred route because it offers flexibility in terms of structure and tax treatment, and it is easiest to maintain. That said, in some cases a traditional corporation is still the better route. For example, entrepreneurs who plan to seek venture capital funding in the near term will want to form a traditional corporation, which is still the more accepted route in the eyes of venture capital investors. (In fact, if this is your path, you should check out Founders Workbench at www.foundersworkbench.com. This is a great tool for technology start-ups with venture funding as their goal.)

Tax questions also come into play in the decision. Many small businesses can save on FICA, or payroll taxes, by forming your company as a corporation in a way that qualifies for Subchapter S treatment under the US Tax Code. (Actually, there’s no reason an LLC can’t qualify as a Subchapter S corporation, though you would need to customize your company documents if you take that route, whereas a standard corporation is likely to work as/is.) On the other hand, if your business is just getting started, and you want to keep things very simple, a single-owner LLC is a path that will not complicate your personal taxes, as the IRS essentially disregards single-owner LLCs for tax purposes.

Another common question is what state to incorporate in. You may have heard that Delaware is the leading venue in terms of corporate law, and this is absolutely true. The well-developed body of corporate law and the sophisticated judiciary there make it a great place to be if you are a Fortune 500 company, a venture-backed start-up or a just a company with a complicated capital structure, and you want to have the certainty and clarity of law to handle the corporate law questions that will inevitably arise. In those cases, forming in Delaware is a really good idea. On the other hand, if it is just you and your spouse who are the owners of your business, the extra expense of forming in a state like Delaware may not be justified when you can save hundreds and sometimes thousands of dollars per year (and some administrative hassle) by staying in your home state. Why is it generally going to be cheaper to stay in your home state? A couple reasons. First, any company not domiciled in a state in which it does business has to also register in that state. In other words, if you have formed your company in Delaware, but your operations are in Idaho, you will effectively be paying two company taxes: one in Delaware and another in Idaho. Even worse, you will be required by Delaware to have a “registered agent” in Delaware. All states require that companies who are domiciled or registered in their state maintain an address in that state where official documents and notices can be sent. There are service agents who will do this for you–but for a fee. However, if you form your company in the same state where your business is located, most states will allow you to simply use your own office address as the registered agent.