When To Form an Entity for Your Business
Starting a business or transitioning from operating as a sole proprietorship or partnership (what you have if you are doing business without forming a LLC, corporation, or other entity) to forming an entity can be an important step in your business. For some businesses it’s the correct move right from the start, for others maybe you have been operating for a while and you are looking to expand your business or hire independent contractors or employees.
Forming an entity can be a great way to separate your personal liability from your business. By forming an LLC (Limited Liability Company), corporation, or other entity only your business assets are at risk if you are sued or found liable for an action of your business. This protects your personal assets such as your home, car, etc. from risk. An entity can also provide other benefits such as structure, registration of the business name, and other components.
But deciding the right time to form an entity is an important and personal decision for your business. So if you’re trying to decide if forming an entity (and spending the $$ on forming one) makes sense, there are a few key factors to consider:
1. Are you in a higher risk business? For example food based businesses, construction, in-person services, and others where there is higher risk for mishaps, illness, and injuries should consider forming an entity from the beginning so that the owners are protected from risk. For other businesses like graphic design, copywriting, consulting, etc. that are lower risk the immediate need for liability protection may be less. However, you should weigh other considerations and benefits of an entity.
2. Do you want to operate under a name other than your personal name? If you want to name your business something other than your personal name, forming an entity allows you to do that and get the benefit of liability protection. If you don’t form an entity then you have to file a fictitious name with the state so that consumers can identify that you are affiliated with the company name. This also has an advertising fee cost, which can sometimes make fictitious name registration more time/cost intensive than forming an entity.
3. Does the business have more than one owner? If your business has more than one owner then an entity can provide structure for how the owners will make decisions, work together, and operate the business. It also is good to form an entity if you have multiple owners so that the actions of one owner doesn’t put the personal assets of another owner at risk.
4. Do you have employees or independent contractors? Growing your team is a good sign of a thriving business but with more people comes more potential liability. What if your business is sued because of something you contracted someone to do? What if you have employee issues? Having an entity can help protect you and can make it easier to file for all your state and federal registrations without having to change them down the road.
5. Do you plan to apply for grants or funding? Having an entity can make it easier to apply for grant programs, funding sources, and loans. These programs often request to see a copy of your state registration, EIN, and other documents. So getting things formalized prior to applying can make it so you already have everything ready when it’s time to apply.
Talking to an accountant can also be helpful in making your decision as they can explain the different tax options and how to plan for bookkeeping once you have an entity.
With a new year just around the corner, now is a good time to be thinking about these considerations as forming an entity in the new year can make it easier for tax purposes, and allows you to start the new year with a new business entity and plan!
If you form an LLC, or already have one, also check out one of our affordable operating agreement templates to make sure you have the proper governing document for your business.
A lawyer can help walk you through all these considerations and more in relation to your specific business and remember, you can always reach out to Trellis for a free consultation!
DISCLAIMER: This blog post is meant for informational purposes only and does not constitute specific legal advice or create an attorney-client relationship. Readers should discuss their specific situation with an attorney.