Business Law Basics: How To Form an LLC (or Corporation)
You’ve seen the commercials on TV and the ads in your Facebook feed about how easy it is to form an LLC or corporation. You just pay the service provider $XX.95 and you’ll be in business. Well, that’s true and not true.
Yes, it is very easy to form a business entity. Kind of like, it’s very easy to make a baby. “Formation” isn’t the hard part. The hard part is in everything else.
The hard part about business formation is choosing the right type of entity in accordance with the short and long term goals of the business and structuring the entity in compliance with state law and for the tax efficiency and limited liability benefits.
This article will address the easy part about forming a business entity. Before we get to the nuts and bolts of formation, let’s talk about what a business entity is.
A business entity is considered a person under the law. Sounds weird, I know, but yes, you read that right. Businesses are people under the law. That means a business entity has a separate legal identity from its owners.
Business entities are a product of state law. Each state has a corporation statute, a limited liability company statute, a partnership statute, and perhaps a few others like one for special entities such as professional corporations (businesses owned by licensed professionals such as physicians or lawyers). These statutes have some similarities across states but also have many differences.
When you form your business entity, it is governed by the statute under which it is formed. So for example, if you form an Illinois LLC, your business entity is governed by the Illinois Limited Liability Company Act. This means that the default rules for your business entity are found in that statute.
Okay, so now we now have the nuts of how an entity is formed. Let’s move on to the bolts… actual formation.
Each state has an agency that handles business affairs. In Illinois, the Secretary of State carries this role. This differs by state, however.
The business affairs agency of the state will have form documents that you must file to create your business entity. These forms are usually quite short. On average they’re less than 5 pages.
You’ll fill out the names and addresses of the owners, your office address, your registered agent name and address, the purpose of your business entity and a few more standard pieces of information depending on what type of entity you’re forming.
You sign the document, write your check, and mail everything (or submit it online) to the business affairs agency. They’ll review it for completeness and make sure no other business in the state is registered under that name. Then they’ll put your company name on the official register for the state and BOOM, you’re in business.
Yep. It’s that easy. Again, filing the documents isn’t the hard part. So don’t let the simplicity of this aspect of business formation distract you from the complexities of the rest of the process.
When using online non-lawyer services to form your business, they’ve simply streamlined the easy part for you and can’t and won’t give you legal advice on the hard parts. Only a lawyer can do that.
So what are the consequences of phoning it in on the hard parts? If you choose the wrong type of entity, you could run into problems with the IRS, problems with governance, or have trouble with investors later down the line. If your entity isn’t structured properly, it can cause tax problems, issues with co-founders, scare off investors, and open you up to liability.
These problems manifest themselves in bad shareholder agreements, poorly written bylaws, generic operating agreements not tailored for your business or when the business has none of these documents at all. A lawyer will put together these documents for you and ensure that the documents fit the company’s needs.
Finally, there are exceptions to what kinds of liability the entity protects you from. You’ll want a lawyer to counsel you on how and where you’re vulnerable and ways to protect yourself.
You want to give your business the best chance of survival and success, so make sure you start off on the right foot by addressing both the easy AND the hard parts.