The Do’s and Don’ts of Corporate Formation
Forming a business can be daunting. There are many different business structures that have pros and cons, but navigating through the minutia to figure out which is best for your specific business is necessary. In the state of Georgia, there are six types of domestic businesses that one can register with the Secretary of State:
A for-profit corporation
A non-profit corporation
A professional corporation
A limited liability company
A limited partnership
A limited liability limited partnership
This article will deal with the two most common types of businesses, a limited liability company, and a for-profit corporation. The article will further highlight the top benefits of each, and the main detractor from both.
Forming a Limited Liability Company
A Limited Liability Company (“LLC”), is a form of business that is owned by something called a “Member”. These members can be an individual or another entity (like an LLC) and the members can participate in management of the business, or they can elect to be passive and have others manage the day to day business. The membership interest can be as few as one member, or as many members as desired. Most often, LLC’s are used by people who want to start a business by themselves or with a partner.
Top Advantages of an LLC
Liability Protection: The main benefit of an LLC, as the name implies, is that it limits the liability of its members. The liability is limited to the total investment an individual member has put into the business, and nothing more. Additionally, members of an LLC are not personally liable for the debts of the LLC. There is one caveat, however, where a member has acted fraudulently or negligently in their conduct, then they may be personally liable for the debts of the LLC.
Paperwork: Creating and operating an LLC is designed to be simple. The business structure requires minimal paperwork to be effective. Outside of filing for registration with the Secretary of State, an LLC only needs an enacted Operating Agreement (explained later) to be a fully functioning LLC. Taxation: An LLC is taxed as a partnership of its members, so it is pass-through taxation. What pass-through taxation means is that there are no corporate level taxes, and the only taxes are on the profit distribution to its members, at their individual tax bracket.
Control: As an LLC is owned and operated by its members, this gives a lot of flexibility on how the business is managed, how new members are admitted, and how the business distributes profits. All of these things are controlled by the Operating Agreement, and as this document is created by its founding members, it can be molded to fit their specific needs.
Investment Type: As long as an LLC is member managed, the investment by its members will not be considered a security under the Securities Act of 1933. This is important for businesses as securities are highly regulated, complex, and costly, and avoiding having your investment being classified as a security is important for new businesses. As such, in most scenarios, membership interest in an LLC can avoid being treated as a security.
Top Disadvantage of an LLC
Raising Capital: Finding new investors for an LLC can be tricky as most institutional investors either only invest in corporations, or invest in businesses that they want to be a passive investor. As an LLC member generally has some management role in the business, so as to avoid being classified as a security, being an LLC will limit your potential reach for new investment and makes it harder to grow with outside funds. Additionally, corporations can have vastly more shareholders than an LLC can have members.
Now What?
Now that you understand the basics of an LLC, lets discuss the process of forming one. First and foremost, you must pick a business name that is not already registered with the Secretary of State. In Georgia, you can visit https://ecorp.sos.ga.gov/BusinessSearch and search for current registered businesses in the state, and see if your name is already in use. If your name is not in use, or a similar name does not seem to conflict, we can potentially file for your registration. The registration fee to register your LLC with the State is $100 and the Annual Registration fee, which is due by April 1st of every subsequent year, is $50. Once your registration fee has been paid, usually within a week the Secretary of State will approve or deny your registration. Once approved, your LLC is now a recognized business in the State of Georgia and there are two important steps to take.
Once your LLC is registered, you can file with the IRS to obtain a taxpayer identification number for your business. This will allow you to file your corporate tax returns (although you don’t pay taxes, you still need to file a tax return for the business) and it will allow you to open up a bank account, credit card, and other important financial services necessary to run your business.
Second, you will want to draft and enact an Operating Agreement. An Operating Agreement is a binding document that outlines the rules, regulations, and decision process for the business. The Operating Agreement will include provisions that limit its members liability, outline how the business is to be managed and under what circumstances things can occur. The Operating Agreement is a malleable document that the members can modify with amendments, and it is the lifeblood of an LLC. Most importantly, the Operating Agreement will outline ownership of the LLC and who its members are. It is important to have a well drafted Operating Agreement so there is no confusion between its members on how the business will run, who makes what decisions, and how much of the LLC does each member own. The most common dispute among members is about ownership and distributions, so having a well drafted Operating Agreement will ensure that there are no problems down the road by making everyone's intent clear from the onset.
Forming a For-Profit Corporation
A For-Profit Corporation, either a C Corp or S Corp, is a form of business that is owned by something called a “Shareholder”. Like the LLC, these shareholders can be an individual or another entity (like an LLC) and unlike the LLC they cannot participate in management of the business. The shareholders of a corporation can be as few as one, or as many as your issued shares allow (more on that later). Most often, corporations are used by people who want to start a business by themselves but raise capital from investors. As corporation shareholders are passive investors, it is a form of business that allows people to invest in things without having to take an active role in its management.
Top Advantages of a Corporation
Liability Protection: The main benefit of a corporation is that it limits the liability of its shareholders. The liability is limited to the total investment an individual shareholder has put into the business when buying its shares, and nothing more. This means that a shareholder’s liability is capped at the value of its shares.
Raising Capital: If you desire to grow your business through external capital, a corporation offers the best vehicle for investment. There can be many types of stock issued in a corporation that have different rights. Corporations can issue non-voting stock that allows an investor to benefit in the profits of the corporation but gives them no voting rights or control over management. Corporations can additionally issue preferred stock that gives the shareholder rights to dividends or special voting rights over management of the business. The corporate structure is very attractive to outside investment as it is protective of its shareholders but also is easy to sell the stock and raise capital.
Flexibility of Ownership: As stock in a corporation is more fungible than membership interests in an LLC, changing ownership is easier and more efficient. If owners of a corporation wish to sell some, or all, of their stock, it is a function of the corporate structure and generally has few restrictions.
Top Disadvantage of a Corporation
Taxation: Owners of a corporation will be subject to tax twice. Once at the corporate level, then again at the shareholder level. Every year a corporation will be taxed on its revenues. Should the corporation be profitable and distribute its profits as a dividend to its shareholders, then the shareholders will also be taxed individually on those dividends.
Now What?
Now that you understand the basics of a corporation, let's discuss the process of forming one. First and foremost, like an LLC, you must pick a business name that is not already registered with the Secretary of State. In Georgia, you can visit the Georgia Corporations Division website and search for current registered businesses in the state to see if your name is already in use. If your name is not in use, or a similar name does not seem to conflict, you can now draft your Articles of Incorporation and file for registration.
Like the Operating Agreement, the Articles of Incorporation is the lifeblood of the corporation. The Articles of Incorporation will dictate how the business is run, what types of stock the corporation can issue, who manages the business, who has liability, and many more things. Unlike with the LLC, a corporation must file their Articles of Incorporation before completing their registration. The registration fee to register your corporation is $100 and the Annual Registration fee, which is due by April 1st of every subsequent year, is $50. Once your registration fee has been paid, and your Articles of Incorporation have been filed, usually within a week the Secretary of State will approve or deny your registration. Once approved, your corporation is now a recognized business in the State of Georgia and there are two important steps to take.
First, now that your corporation is registered, you can file with the IRS to obtain a taxpayer identification number for your business. Just like in an LLC, this will allow you to file your corporate tax returns and it will allow you to open up a bank account, credit card, and other important financial services necessary to run your business.
Second, you will want to consult with a financial advisor/Attorney to discuss the process and steps of issuing stock in order to raise capital. Issuing stock is a complex process and can be costly. Finding the right advisor to help you through this process is necessary to ensure your corporation follows the regulations of the Securities Act of 1933. Legal compliance with securities laws is a must for a for-profit corporation.
What Conway Eader Can Do for You
Forming a corporation or an LLC is important to protect and separate yourself and your business interests. Doing so the correct way from the start will help to reduce mistakes and risks that could become major problems later in the life of the company when the stakes are higher. Conway Eader has experience helping businesses establish the perfect corporate structures for their needs, while also facilitating and overseeing their enactment while serving as trusted advisors. At Conway Eader, we offer an all-in flat rate of $500 for any type of business registration. This cost includes all government filing fees, full drafting of an Operating Agreement or Articles of Incorporation specific to your business needs, and the firm's ongoing services as the company's registered agent for the first year. If you think you might have a business that is ready to be formally incorporated, please do not hesitate to contact Conway Eader. All consultations are given free of charge.