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A new business typically will be formed as a corporation or as a limited liability company. In some cases, the business entity will be a partnership or simply a sole proprietorship. Corporation: A corporation in New York State is formed by filing with the Department of State a certificate of incorporation. The incorporator, who must be a natural person over the age of 18 years, signs the certificate of incorporation. It is best to first make sure that the name chosen for the corporation is available, that is, it is not already taken or is not so similar to an existing corporate name as to be confusing or misleading and cause the name to be rejected by the Department of State. Also, you will need to be sure that the name chosen is not prohibited or restricted by law - there are many names that are prohibited or restricted, such as preschool, prekindergarten, nursery school, historical, savings, blind, handicapped, and mortgage. The next steps are to elect directors and officers (typically a President, a Secretary and a Treasurer), authorize the issuance of shares of stock, and issue shares of stock to shareholders. Note that a corporation may have as few as one director and the same person who is a director may also be the President, Secretary and Treasurer, as well as the sole shareholder. The corporation also will adopt by-laws. If there is more than one shareholder, the shareholders may want to and should consider a shareholders agreement (discussed elsewhere) and placing restrictions on the transfer or sale of the shares of stock. The owners (that is, the shareholders) of the corporation may also wish to file forms with the Internal Revenue Service and with the New York Department of Taxation and Finance to elect to be taxed under Subchapter S of the Internal Revenue Code, so that income taxes at the corporate level may be avoided. After doing so, the corporation would be an “S corporation”. A corporation ordinarily has perpetuity, that is, its existence does not depend on the continuing participation of the original owners or even on the original owners being alive. A corporation also has easy transferability of its ownership, through sale or transfer or issuance of shares of stock in the corporation. Limited Liability Company: A limited liability company (“LLC”) is formed, in New York State, by filing with the Department of State articles of organization. The articles of organization are signed by the organizer of the LLC. Note that, unlike in the formation of a corporation, the organizer need not be a natural person but may be an entity such as a corporation or even another LLC. An LLC does not have shareholders but instead has members. The members are the “owners” of the LLC. The members are required to adopt an Operating Agreement. The Operating Agreement sets forth the relative rights, obligations and liabilities of the members as between themselves and as between themselves and the LLC. It is a confidential document, that is, it is not filed with the Department of State and is not public. As with forming a corporation, it is best to first check to make sure that the proposed name of the LLC is available. In connection with the formation of the LLC, the organizers will need to publish a legal notice of the formation in two newspapers for six consecutive weeks. When publication is completed, affidavits of publication together with a certificate of publication are filed with the Department of State. Finally, at some point the members may wish to consider drafting a further agreement among themselves, to cover matters or circumstances not covered by the Operating Agreement. Partnership: As with corporations and limited liability companies, a partnership is governed by statute, as well as by case law. A partnership arises where two or more persons associate themselves to carry on, as co-owners, a business or venture for profit. Note that a “person” need not be a natural person but may be, for example, a corporation or limited liability company. A partnership usually arises by an agreement of some kind, which may be oral or written or even implied by the actions of the parties. Unlike the formation of a corporation or a limited liability company, a filing with a state or local office is not required in order to create a partnership. However, there is commonly one filing which is made, which is the filing in the county clerk’s office of a certificate of conducting business under an assumed name, commonly referred to as a “dba certificate”. This filing is required where the partners conduct business under a name other than their own names. Proprietorship: A proprietorship is one person conducting a business without a partner and without the formality of having formed a corporation or a limited liability company or any other business entity. As with a partnership, there is no filing required with any local or state office in order to create a proprietorship. Again as with a partnership, the owner may also be required to file with the county clerk’s office a certificate of conducting business under an assumed name. Choosing the Form of Business Entity My experience has been that clients typically consider the following when deciding what entity to use in their business start-up, in descending order of concern:
Corporation: A corporation provides its owners (the shareholders) with limited personal liability under ordinary circumstances. For example, the shareholders are shielded from creditors of the corporation, from debts of the corporation and from lawsuits against the corporation. A corporation is a separate legal entity from the owners and may enter into its own contracts, obtain its own loans, hire employees, and operate business premises. The limited liability applies to the shareholders, officers and directors when acting in the ordinary course of business of the corporation. Also, ordinarily a shareholder, officer or director would not be personally liable for the actions or omissions of another shareholder, officer or director. A corporation is taxed as a separate entity. This results in two levels of taxation of the profits of a corporation. The first tax is the corporate level and, if profits are distributed to the shareholders, typically in the form of dividends, the dividends are then taxed to the individual shareholder on his or her personal income tax returns. A common way to avoid this “double taxation” is for the corporation to elect to be taxed as an “S corporation”. Qualifying as an S corporation means that there would be no separate tax at the corporate level and profits are passed through directly to the shareholders to be taxed on their individual income tax returns. Note however that while many small corporations may qualify to be taxed as S corporations, not all corporations would be eligible. A practical benefit to operating as a corporation is that the business will look more permanent and businesslike than simply being a partnership or a proprietorship. The filing fees and costs to meet the minimum requirements to form a corporation are substantially lower than those filing fees and costs to form a limited liability company. The filing fee to file a certificate of incorporation and associated fees to be paid to the Department of State usually total less than $200.00. And, while it is certainly advisable to consider drafting a shareholders agreement if there are to be two or more shareholders, it is not required, unlike with a limited liability company, which is required to have an Operating Agreement. Limited Liability Company: As with a corporation, the individual members of a limited liability company will have limited personal liability for the debts and obligations of the company. If the business at some point is sued because it is unable to pay its debts, unless a member has guaranteed the obligation, the member ordinarily has no personal liability for the debt. Also, ordinarily a member or officer of an LLC would not be personally liable for the acts or omissions of another member or officer. An LLC enjoys “pass-through taxation”, as with an S corporation. Where persons who wish to form a business would like the benefit of pass-through taxation but find that their business will not qualify to be taxed as an S corporation, they may instead decide to form an LLC. The filing fees and other expenses required in order to form an LLC may be significantly more than the expenses and costs of forming a corporation. The filing fees and costs include, at a minimum, the fee to file the articles of organization with the Department of State and the costs of publishing the notice of formation of the LLC in two newspapers for six consecutive weeks. There is also the cost of drafting an Operating Agreement, especially where there are two or more members of the LLC - the two or more members may have different goals, skills or contributions to the business and hence there may be a fair amount of negotiation between them in deciding what the terms and provisions of the Operating Agreement should be and, in some cases in negotiating the Operating Agreement, each member may end-up having separate counsel. Unlike with a corporation, there is some flexibility in allocating profits and losses to the members of the LLC. Distributions may be made by agreement and not necessarily in proportion to the ownership interest of each member of the LLC. Because an LLC does not have stock, there are no share certificates, and hence it is difficult to raise public or private investment money because there are no shares to offer. Also, there would be no stock options to offer as incentives to employees. Also, while an LLC ordinarily is able to deduct the cost of fringe benefits, such a health insurance, for its employees, it may not able to deduct the cost of fringe benefits for its members. Partnership: Unlike with a corporation or an LLC, there is no broad limited personal liability for the partners. Each partner is ordinarily personally liable for the debts and obligations of the partnership and each partner is ordinarily personally liable for the acts and omissions of each of the other partners. Hence, there is usually an immediate need for substantial liability insurance to at least cover injuries and damages that may happen on the premises or by reason of the business of the partnership. A partnership is inexpensive to form. Typically, the only filing fees that would be involved would be the fee to file with the office of the county clerk a certificate of doing business under an assumed name (if the partners will be conducting business under a name other than their own names) and, while not required, the cost of drafting a partnership agreement. Proprietorship: A proprietorship is the simplest form of doing business. No particular act is required to start the business, other than perhaps filing with the county clerk’s office a certificate of conducting business under an assumed name (if conducting business under a name other than the owner’s own name). A sole proprietor has personal liability for the debts and obligations of the business; there is no limited personal liability. If a lawsuit results in a judgment against the business, the judgment will also be against the sole proprietor and the personal assets of the proprietor may be reached to pay-off the judgment. As with a partnership, liability insurance is recommended to at least protect the personal assets of the proprietor against injuries and damages occurring on business premises or occurring in the course of business. A liability may not, for example, merely be the result of someone being injured on the business premises but instead could be for providing workmanship or services that damage a customer. |
