A clear plan and careful preparation are vital to know the path forward.
Last time, I talked about the two fundamentals of starting your own small business: having a plan and the capital to make it work.
READ MORE: Business plan, capital are first steps to starting any successful business
Today, I want to go over some of the mechanics of bringing your dream to its early reality. These steps may not be the same for every business. However, they are the most common ones in my experience for people starting a new business from scratch, once they have a plan in place, and the financial resources to bring it to life.
None of these steps require an attorney or accountant. You can, in theory, do them all yourself. It will depend on your own aptitude and comfort level. While having an attorney or accountant help will be an up-front expense, her/his cost will be far less than what you will have to pay her or him to correct any mistakes you make in completing the steps below.
Again, that pesky, mandatory disclaimer: I am not your lawyer. What I tell you below is not legal advice. The advice/suggestions I am giving are for general information only and cannot cover every situation or circumstance. If you need advice tailored to your specific needs, you should contact an attorney or certified public accountant.
Operate your business as a legal entity
Old and new clients come to me with almost always the first question: What type of legal entity should I use to operate my business? It has been many years since anyone has asked me: “Should I form a corporation (or LLC or something)?” Being a solo or DBA (e.g., “John Doe d/b/a Downtown Tacos”) or a partnership is not a good option. I have not set up a true, general partnership in my entire 30-year career.
Outside of some obscure tax issue (for which I hope you already have a CPA), I believe there is no reason not to have your business be in some legal entity. Corporations and LLCs can provide you and your other business owners with protection from potential liability to third parties. That protection is not absolute, but it is far better than going without operating as a legal entity. Also, there can be some tax advantages operating as a legal entity as opposed to running your business simply as “John Doe d/b/a Downtown Tacos”.
Which type of entity should I choose?
For many years, a corporation was the go-to entity for most people forming a legal entity. However, they do have their own administrative requirements, and are subject to several tax burdens while other entities are not. Limited partnerships can serve as a vehicle for holding interests in real property, providing venture capital/private equity to businesses, managing investment funds, etc. However, limited partnerships can be very expensive to form, and require detailed agreements to establish and safeguard the liability protections they offer.
These days THE entity best suited for start-up business is a limited liability company or LLC. They offer almost the exact same liability protection a corporation does, but with a lot more flexibility in terms of its internal structure and organization. LLCs can be structured to operate like a solo business, a partnership (both general or limited), or a corporation. They can have multiple layers of ownership, segregate/protect assets without subsidiaries (i.e. “Series LLC), own other types of businesses, be a vehicle for family estate planning or simply just sit there and hold an asset. LLCs are everywhere from your neighborhood sandwich shop, all the way to Anheuser-Busch Companies, LLC.
In which state should I form my business?
That answer is easy. I have formed entities in over 18 states, including all the states which border Mississippi, Florida, Georgia, New York, Nevada, Wyoming, Montana, California and Delaware. Hands-down, forming an entity in Mississippi is easier than anywhere else I have experienced. If you know what you are doing, you can form an entity on the Secretary of State’s web site in 10 minutes. I timed myself once and did it in two minutes. It took me longer to pay with my credit card than to fill out the LLC form.
There used to be some cache’ to forming an entity in certain states like Delaware for corporations and Wyoming or Nevada for an LLC. Unless you want to do a future Wall Street IPO, or seriously restrict the rights of your members/owners, then you will do just fine with an entity formed in Mississippi. Mississippi’s Revised LLC Act is flexible and fits the bill 99.9% of the time.
There is one huge disadvantage to forming your entity outside of Mississippi: your business can now be sued in that state. So, before you get any ideas you want to be formed in Delaware, if you do that then remember you can be sued for anything in Delaware (and those lawyers will charge a lot more than your Mississippi lawyer will to defend your company).
Get your EIN from the IRS
An Employer Identification Number (“EIN”) for your business is like your social security number. It is how the US Government, state government (to a large extent) and banks or financial service companies will track your income, expenses and various tax returns you will have to file. While there are internet services who will charge you hundreds of dollars to do so, again if you know what you are doing, you can get an EIN directly from the IRS in minutes for free.
Sounds great, right? It is, but do not try to get an EIN yourself. The IRS’s online process has several questions which you must answer about your business going forward. An incorrect answer or “best guess” can create major headaches for you and your accountant down the road. Correcting with the IRS inaccurate information from an EIN application after your number has been issued can be an expensive undertaking. I have seen accountants/clients completely abandon an EIN when the cost of correcting it was more than the hassle of forming a different entity with a new EIN. Get your accountant (or an experienced attorney) to get your EIN.
Note: depending on your type of business, you may need to get a separate tax number from the Mississippi Department of Revenue (e.g. sales tax, excise tax, employee withholding)
Create your foundational documents
Articles of Incorporation and Certificates of Formation are the foundational documents for corporations and LLCs, respectively. These two documents can be used to establish (or restrict) the basic rights of shareholders and members. While often filed in their most basic forms, in entities with varying levels of ownership, they serve a useful purpose in preventing a simple majority of members or shareholders from changing the purpose or fundamental nature of your new entity.
Other documents are often prepared to govern how a corporation or LLC operates, and the respective powers of its directors, managers, officers, etc. Bylaws typically address how a corporation’s board of directors and officers are selected, define the scope of their authority, and how they interact with each other and the shareholders in general.
Operating agreements serve as the counterpart of bylaws for LLCs. Although Mississippi law does not require LLCs to have one, operating agreements range from simple (2-3 pages) to very complex (50-60 pages). There is no typical formula for an operating agreement, other than they usually outline the rights of the manager(s) and officers to operate a business, versus those rights reserved exclusively to the members (i.e. LLC owners). For example, a small business might have four members, one of whom is responsible for the day-to-day operations. The operating agreement could state the manager is responsible for managing, hiring and firing employees and entering into contracts in the normal course of business. That same agreement might reserve to members the exclusive right to (a) buy/sell real property and (b) authorize the LLC to incur debt above a specific dollar amount.
#####
The list I have given you is not exhaustive. You may need one or more permits from a federal, state or local government agency to conduct your operations. Your business may need to enter into conditional agreements with public agencies or private companies or even individuals to secure necessary legal rights to start your business. A clear plan and careful preparation are vital to know the path forward.
Finally, there are numerous online providers who can do some of these steps for you. While they are less expensive than a lawyer, they have their shortcomings.
First, in my experience, they are not that much cheaper than most attorneys. I have found my charge to set up a single-member LLC with an EIN is within 10%-20% of what you would pay online. Plus, an attorney or accountant would spend time getting you familiar with the process and answering some basic questions. I have yet to see an online service provide tailored personal advice from an actual attorney as part of their cost.
Second, the more complex your business is in terms of capital needs and investors/owners, the more imperative it is to get advice from an accountant, and an experienced attorney. The price you pay for an online service is often for a one-size fits all product. I am not saying it is bad; it just may not address all the details and circumstances of your particular business. Again, spending some money to meet with an attorney in your area who has experience in helping small businesses get started can save you a lot of time and aggravation.
