One of the biggest questions new entrepreneurs have about starting a new business is how to actually structure the business they are creating, and whether they need to worry about it at all. SO many people rely on advice from non-lawyers on this topic, it becomes challenging as a lawyer to keep up with all the false or inaccurate information circulating on social media about LLCs, sole proprietorships, how and when to set one up, and whether a specific business entity is necessary or not.
FIRST – a quick rundown of the two most common business structures:
- Sole Proprietorship
This is the business structure that is automatically created when you start a business, and do not register or create any other business entity. You don’t need to register as a sole proprietor, or do anything specific to create one; it is the default form of business for any individual who is operating a business in any way. (This could be everyone from Etsy shops to coaches or consultants). For this reason, it is very easy to set up, and costs almost nothing. The primary thing to keep in mind here is that there is no separation between you and your business as a sole proprietorship – they are one in the same. The negative here (and why the sole proprietorship sometimes gets a bad reputation) is that if your business were to be sued or held responsible for something, your personal assets could be on the line, too. So for example, if you were sued and lost, and there was a judgment against you for $100,000, but your business assets only added up to $50,000, the court could look at your personal assets as well to get the other $50,000, including your car, house, personal bank accounts, etc.
However, in some businesses, the liability is fairly low, and business owners are equipped with great insurance that will cover them in the event of a lawsuit or claim of responsibility in some way. For that reason, sole proprietorships can be great for many business owners.
- Limited Liability Company (LLC)
This is the most common business entity for new and budding entrepreneurs – the limited liability company, or LLC. The LLC is formed by filing several documents with your Secretary of State: the Articles of Organization and the Statement of Information. From there, the business owner will need a Tax-ID number (or EIN), and in many states, an Operating Agreement. The startup costs are higher to correctly set up an LLC — and I highly recommend you consult with a lawyer to set this up for you — and there are annual fees to keep the LLC current. Once the LLC is properly formed, and assuming business is conducted properly, the LLC will shield you from personal liability from any wrongdoing of the LLC.
In an effort to answer the FAQ’s related to business structure, entity creation, and how this all works, I have created a list of my most frequently asked questions on this subject. Hopefully this helps clear up any confusion or questions about business entities.
COMMON QUESTIONS ABOUT BUSINESS ENTITIES:
Q: If you just start taking on clients using your personal name…have you created a business?
A: YES! Often times business owners think they have not yet created a business if they just start doing business under their legal name, and end up asking if/when they should consider entities like sole proprietorships or LLCs. BUT – this is a common myth! As soon as you start offering services and taking on clients as a business, you are automatically a Sole Proprietor! This means, from the beginning you should be doing things like: (1) putting all business revenue in a separate bank account, (2) keeping track of all business expenses, (3) looking into things like liability insurance or other risk reducers if you plan to continue the business as a sole proprietor.
Q: If you start taking on clients under a business name, but haven’t registered that business name anywhere or created a LLC…is that okay?
A: NO! As soon as you start doing business, you are a sole proprietor, doing business under your legal name. If you plan to use any type of business name, or any name other than your legal name, you will need to register what’s called a “DBA” (which stands for “doing business as”) or a fictitious business name in your county (county, not country).
Your county clerk will have a website, and will allow you to register a fictitious business name or DBA by filling out one or more specific forms you’ll be able to download from their site. Once that process is done, you will then enter into all contracts as [your name], a sole proprietorship doing business as [business name].
Q. If you create an LLC through your state, do you have to do business under that name, or can you pick something else?
A: It NEEDS to be under your LLC name. If you plan to run another business under the LLC umbrella, or you plan to do business under a name other than what you called your LLC, you will also need to file for and register that name as a “DBA” under your LLC. Once that process is done, you will then enter into contracts as [name of your LLC], a Limited Liability Company doing business as [business name].
Q. Do I HAVE to be an LLC in order to run my business?
A: NO!! This is one of the most common myths I see on social media, and the most incorrect piece of advice I see given by some non-lawyers. No. You absolutely do NOT need to create a limited liability company in order to run your online business. Many businesses elect to run as a sole proprietorship (I did for the first year or two of mine!) based on factors such as costs, potential risks or liabilities in their line of work, and where they see their business going in the short term. While it is slightly “riskier” to operate as a sole proprietorship in some cases, often times liability insurance covers much of the actual risk, and it ends up perfectly acceptable to operate as a sole proprietorship.
Additionally, some will elect to create a corporation or partnership, rather than an LLC, and operate this way. An LLC is just one option in the world of business entities, and there is never a requirement to operate as any specific business entity.
Q. Is an S-Corp a business entity?
A: Nope – it is just a tax election; meaning, you could be either an LLC or a C-Corporation, and simply elect to be taxed as an S-Corporation. So if someone says they are an S-Corp, what this tells you is that they have (or their accountant has) elected to be taxed as an S-Corp; they may have structured their business as an LLC or C-Corporation.
Q. Which business entity is the BEST?
A: THIS DEPENDS ON YOU AND YOUR BUSINESS! Do NOT let anyone else (other than your accountant or lawyer) tell you which business entity to create, or how to run your business. Deciding which business structure or entity is best for you largely depends on:
- Which state you live in (rules are very different by state)
- Your annual revenue and tax bracket
- How you plan to run your company
- Whether you plan to expand your business, hire employees or contractors
- How much liability you create in your services
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