Benjamin Franklin famously said, "There are only two certainties in life -- death and taxes." For entrepreneurs, choosing the most appropriate business structure may reduce the latter of life's certainties. The business structure not only affects the amount of taxes paid, but also establishes the level of personal liability, establishes record keeping requirements, and delineates the investors' role.
Personal Liability and Taxes
Just as there are two certainties in life, there are two predominant considerations when choosing a business structure: personal liability and taxes.
Entrepreneurs forming a corporation can elect to be taxed as an S-Corporation. While S-Corporations eliminate double taxation, they may have no more than 100 shareholders and may issue only one class of stock.
Today, LLCs provide businesses with limited personal liability and the ability to elect "pass-through" or corporate tax treatment. LLCs also provide entrepreneurs the opportunity to create a flexible business structure that meets their needs, without the restrictions associated with S-Corporations.
The Impact of Business Structure on Funding
Startup businesses usually raise funds through a combination of debt and equity. Debt, especially in start up businesses, will likely require granting security to the lender and the members personally guaranteeing the debt if it is not obtained from family or friends. Debt also must be repaid, which can reduce cash available for investment in the business or require additional funding.
Alternatively, the business may sell equity to investors. Typically, in a start up business, there are no mandatory payments associated with equity, but the founding entrepreneurs reduce their share of the business's future profits and their decision making authority. At the same time, outside investors may bring experience and specific expertise to the founding entrepreneurs.
Selling equity may be considered as a sale of a security under Federal or State securities laws, especially if the investor is inactive. Experienced counsel can assist in determining if these laws apply, and if they do, in structuring the transaction so as to be either exempt or in compliance with the related laws and disclosures that generally must accompany a sale of a security.
At the end of the day, the decision as to the type of entity and funding structures can be complex. It is important for entrepreneurs to consider the pros and cons in light of their specific business and growth plans. However, they do not need to analyze these considerations alone -- experienced counsel can help guide them through the process to provide a solid foundation for innovation and growth.
Make sure your counsel is experienced in advising businesses, including startups. Ask them to compare the different types of legal entities available and the one best suited for you given your circumstances. Some firms (including the authors' firm) have put together service packages specifically for startups. In these service packages, attorneys work with the company to determine and establish the type of entity and capital structure that best suits a company's growing needs, so that it can move forward with the proper foundation.
• Dean J. Leffelman is a partner in the DuPage County office of Ice Miller. He focuses his practice on commercial law and transactions including mergers, acquisitions and reorganizations, shareholder agreements, drafting business contracts, employment agreements, tax and business planning, joint venture agreements and estate planning. Dean can be reached at 630-955-6390 or email@example.com.
• Tony Aaron is a partner in Ice Miller's Business Group, concentrating his practice in the areas of business law, aviation and antitrust matters. Tony can be reached at 317-236-2484 or at firstname.lastname@example.org.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.