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Chapter 2
Choosing Corporate Structure
for your E-Business
Business Law Basics
Too many small businesses – and especially, online businesses - begin operations without first
thinking through their corporate structure. We’ve seen it all too many times. You have wild success
in business, only to be sued by someone that blindsides you because you didn’t take the time to fill
out the simple paperwork and spend the little bit of money necessary to ensure that you limit your
liability.
This is especially important if you want to do business online where many competitors can be
unscrupulous and new laws such as CAN-SPAM (Controlling the Assault of Non-Solicited
Pornography And Marketing Act of 2003), which was designed to limit email spamming) are
popping up continuously in order to regulate the Wild West of the Web.
So we’ll spend a little bit of time on this subject since it’s so important.
There are several legal issues you should look into when beginning a new business. Make sure you
review your legal needs, including; trademarks, patents, copyrights, doing-business-as (DBA)
/business names, and even personal legal issues that may impact your business, such as: divorce
situations, wills, prenuptial agreements, power of attorney, and wills.
For these legal issues, we recommend that you use the service that you can find now by clicking
here or by checking out the Online Legal Resource that we suggest at www.WhatWeSuggest.com.
One of the most important issues that you should handle first is deciding your corporate structure.
For our recommendation on which company to use for this service, click here or check out the
Online Business Incorporation Service we have listed at www.WhatWeSuggest.com.
Choosing a Corporate Structure that’s Right for You
One of the most common questions we get is: Should I set my company up as an LLC (Limited
Liability Company) or a regular corporation or just start as a sole proprietorship?
As you’ll see, 90% of the time, we recommend you taking the time and spending the money to set
up an LLC, but, as with everything in business – and in life – the one right answer is: It all depends.
It depends on your risk tolerance, the nature of your business, your financing structure, and many
other issues.
For starters, ask yourself the following questions:
- Do you need financing beyond what you can invest yourself or what you can get from friends,
family, and your bank? That is, do you want investors as shareholders in your company?
- Do you want to maintain full control of your company or are you willing to give up some control
in exchange for investments from others?
- Do you want to avoid double taxation, that is, at the corporate level and then at the individual
level?
- Are you willing to live with the risk of liabilities that may arise from your doing business?
The answers to these questions will help you choose the right corporate structure that will
ultimately fit your needs.
Here’s an overview of the main options that you have. Please be very careful with this decision. We
are not attorneys so we suggest you consult with one so that you make the right choice.
Sole Proprietorship
If you are starting a business more as a hobby, you’ll probably want to avoid paying the fees
necessary to incorporate. Many people start with a hobby and then try to grow it into a money-
making venture. Or, you might have a relatively straight-forward business. You might be a graphic
designer or Web site developer, who wants to just use the Web to generate leads for some extra
income through your freelance work.
In this case, you might just want to keep separate business records, set up a business account
and keep your business-related receipts so that you can write them off as expenses at tax time.
You will want to pay self-employment taxes on a regular basis so as to avoid penalties, and make
sure to report all business-related income on your individual tax return.
The Upsides and Downsides of Sole Proprietorships
The quick-and-dirty benefits of sole proprietorships are that they are (1) easy to start, (2) low-cost,
and you (3) avoid double taxation – that is, you do not have a business entity that is taxed
separately from you as an individual.
But the upsides of sole proprietorships come with a potential cost. The main drawback of this
structure is that you are personally liable for legal claims that may arise against your business. For
example, if a customer decides to sue you for some reason, they can go after both your business
and personal assets.
As you will see, we suggest that anyone who is serious about starting a money-making venture
should invest in incorporation, especially since it is relatively low-cost and simple nowadays. This
small investment is usually a good idea, especially when compared to the nightmare of being wiped
out personally by problems caused by your business. So bottom line is that we suggest you invest
upfront so that you can sleep better at night. It’s worth it. Click here or check out the Online
Business Incorporation Service that we suggest you use at www.WhatWeSuggest.com.
Partnerships
Many people don’t like to do it alone. They might just have a friend that they want to go into
business with – or they need skills or money that another person can provide. In many cases, 1 + 1
= 3, meaning that, for example, you and a partner might be able to get much more done as a team
than either of you can accomplish individually.
In this case, a sole proprietorship is not viable since more than one person will be involved in the
business. Instead, you can form a partnership in which you and your partners are both considered
business owners. Each partner will contribute time, money, and/or skills to the business,
depending upon whatever arrangement you make among yourselves. Be careful to clearly delineate
who is responsible for what upfront because you want to avoid fighting later over how to share
profits, assets, or losses.
General versus Limited Partnerships
There are two main types of partnerships – general and limited. In a general partnership, the
partnership can buy and sell property, products and services as a separate legal entity. However,
you and your partners must report income from the partnership on your individual tax returns.
As with sole proprietorships, the individuals in a general partnership are liable for all of the
obligations of the partnership. There is no limitation on liability. Someone who decides to sue your
partnership can go after both your and your partners’ individual assets. Again, we do not suggest
you form a partnership because of this liability issue.
Alternatively, you can form what is known as a limited partnership where the partners only risk what
they agree to in their partnership contract when they first start the business. In many cases, a
limited partnership is a much more viable option than a general partnership. However, in this case,
we definitely suggest that you consult an attorney before signing such a contract.
C Corporations
If you want to avoid the risk of liability, you must form some type of corporation. Most start-ups will
either incorporate themselves as S Corporations or Limited Liability Corporations. If you want to
sell shares of stock in your business to obtain funding, you might want to consider forming a C
Corporation. Most publicly-traded companies are formed as C Corporations, which means that they
are legal entities separate from the owners, who are called shareholders or stockholders. These
stockholders are not personally responsible for the fees, liabilities and losses of the business.
This might sound like a good choice, however keep in mind that C Corporations are relatively
expensive to start and maintain. To become incorporated, you have to hire an attorney to ensure
that you fill out all of the relevant documents for the state in which you are incorporating, and then
you have to hold annual stockholder meetings, and keep detailed records to avoid any legal or
accounting problems.
And perhaps most importantly, stockholders of a C Corporation must pay taxes on the business
profits at the corporate level and then again when they report their earnings as individuals. This is
known as double taxation.
S Corporations
To avoid the double taxation issue, some choose to form an S Corporation. In this case, the profits
of the business are what is known as “passed-through” to the individuals that own the corporation.
Therefore, the owners only pay taxes once at the individual level. If you expect losses in the short-
run, you might want to incorporate as an S Corporation since you will be able to report a loss on
your personal tax returns and thus minimize the taxes you owe.
However, there are certain limitations of forming an S Corporation that you should be aware of. You
must run your company on a fiscal calendar year, have less than 35 individual stockholders who
must all be U.S. residents, and you can only issue one class of stock. There are other restrictions
which you should review with an attorney before deciding to form an S Corporation.
Limited Liability Corporations – Our Recommendation
Even though we say that you should think about which corporate structure is best for you, most of
the time, we suggest that our clients form Limited Liability Corporations (LLCs). Think of an LLC as
a corporate form that is the best of all possible worlds. It is relatively simple and inexpensive to form
and maintain, and it provides the owner or owners with limited liability.
There are no rules as to who can be a member or manager of an LLC. You can own it by yourself;
you can have family members as co-owners; and you can even have other corporations as the
owners of an LLC. It is very flexible. Like a C Corporation, an LLC is a legal entity separate from the
owners so your personal assets are protected from anyone who might decide to sue the LLC.
Also, an LLC enables you to avoid double taxation. As an owner, you only pay taxes on the profits
that are distributed to you, which you then declare on your individual tax return.
Even though we always recommend speaking to your attorney and/or accountant first, if you want a
do-it-yourself solution, click here or check out the Online Business Incorporation Service that we
are currently recommending at www.WhatWeSuggest.com.
Taxes and Bookkeeping
No matter which corporate structure you decide to adopt for your online venture, you need to keep
your records straight. First-time entrepreneurs, who most often try to handle their own bookkeeping,
should use an off-the-shelf accounting software packages, which will make your life much easier
and will help you get organized right from the start.
For our recommended accounting solution go to www.WhatWeSuggest.com and check out the
Accounting Software Solution, or just click here.
Go to the next Chapter
Chapter 3 - Following a Viable E-Business Model
Advertising
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