When starting a business, you must decide what form of business entity to establish. Depending on a number of factors, some of which hold greater weight than others, your choices might include: C-corporation, S-corporation, B-corporation, LLC, partnership, sole proprietorship, etc.
Entities are not one size fits all, so it is essential that you conduct a thorough analysis to identify which entity matches best with the ongoing needs and goals of your business.
Here are several key things to consider when selecting an entity for your business:
What is the long-term exit strategy for the founders?
Will the business be acquired in five or 10 years?
Will you pass the business on to children?
Will the business continue a noble cause indefinitely? (not-for-profit entity)
How will this venture be funded?
Will you self fund the venture?
Will you target VCs, angel investors, or friends and family to invest funding?
Will you apply for grants/donations/public funding?
Does the entity need limited liability protection?
This depends on the type of business. Limited liability protection is essential for most businesses even if you aren’t selling sharp, dangerous objects. It does not hurt to have an extra layer of protection and other stakeholders (including investors) will insist upon it.
It is useful so your personal assets will not be taken to pay debts of the company. Any kind of business can fall on hard financial times and into debt.
What is the expected financial performance the first 1-2 years?
Will the business be immediately profitable?
Will it run at a loss for a period of time?
Do the founders need a unique arrangement between one another?
If profits will be divided according to ownership, then your entity choices are open. If not, then an LLC that allows for customization might be best.
Will all founders be active or will they be passive?
LLCs allow for some passive structures.
Corporations can have SOPs to reward and incentivize active founders.
How many owners will the business have and will any be non-US citizens?
S corps have restrictions on who can be a shareholder.
How much record keeping do the founders want to do/want to pay for?
Smaller consideration obviously, but sometimes people really care about this. They know they are going to have a tough time remembering to maintain the formalities of a corporation so they opt for an LLC.
Record keeping can increase each year.
If the founders’ goals/plans for the venture change after a few years, can the chosen entity be converted or adjusted to align with these changes?
Perhaps you originally wanted to self-fund and now you want to raise capital from outside investors. Or vice versa.
Which state should be chosen for formation?
We usually look at either the state where the principal place of business will be, or a state like Delaware or Nevada with other advantages.
Don’t just follow the crowd.
As you can see, you must take the time to analyze your business’ needs to determine the correct entity for it. If you need help with choosing an entity for your business, please contact Optima Law Group at 858-964-4697 or email@example.com and we can assist you through the entire process.