NASE Blogs

What NASE Members Want to Know

Saturday, February 20, 2010

Through the professional consultants NASE members have access to ... ShopTalk, TaxTalk, EstateTalk, and ABC’s of Finance ... we get thousands of questions every year on just about every business topic that you can imagine. While I can’t speak for the other pros who guide business owners ... I can offer insight on what’s in the minds of members who call ShopTalk.

Without hesitation I can tell you that the #1 question we get is ... “What is the best business structure”? While the vast majority of businesses start-ups opt for a sole proprietorship, not taking advantage of a Limited Liability Company or a Corporation ... in my opinion ... is like walking around with a stick of dynamite in your pocket.

So what is the best business structure? Well, that depends on you and your business and quite bluntly, there is massive misinformation about choosing the right structure. There is no way that anyone can make a blanket statement for business and any time you hear something that says you ought to be this or that ... my guess is the next thing you hear is how much they will charge you.

So just to get your gray matter working, here is a little business structure 101.

The first point I’ll make is that I seldom suggest operating any business under a sole proprietorship (DBA) due to the unlimited liability to the owner of the business. Regardless of whether you have employees or not or use independent contractors, a sole proprietorship is risky because the “owner” is personally liable for everything that happens in the business ... regardless of whether it was their fault or not. The formation of an LLC or corporation will provide a liability separation between the principle and the business and is one of the least expensive ways to protect yourself in business ... and this goes ditto for operating as a general partnership.

Another basic point to understand is that nobody … absolutely nobody … can suggest which legal (tax) structure is best for a business without analyzing existing and projected financials and tax liabilities under the different scenarios (LLC, or Corporation “C” or “S”). So all those friends and other sources that suggest you incorporate, if they don’t have clue 1 about your business finances ... thank them for their suggestion but run away from them like they had the plague.

But ... back to liability for a moment. One of the primary reasons people consider an LLC or Corporation is to provide that degree of separation between themselves (and their personal assets) and their business activity. Here is where one of the most common misunderstandings comes in ... that by setting up an LLC or Corporation you circumvent all personal liability … this is not entirely correct and you generally can not circumvent liability for your own actions. Example, if I do business with you and sue for something you were personally involved in which caused me damage, I will litigate against your business and you personally. In this case there is a strong possibility that you will have some personal liability. However, if one of your employees, an associate, an independent contractor or a product provider engaged by your business was the cause of the damages you would be more protected and not likely have personal liability.

As for the issue of business finances and taxes, as a very broad statement ... if your taxable business profit is over $40K and under $110K you might benefit from forming an “S” Corporation due to corporate tax advantages. Over $110K in profit either the “S” or “C” Corporation might be a good option or even the LLC. Again, it is impossible for anyone to say what the best entity is without doing some number crunching. It’s also important to understand that an LLC is not a tax entity. In an LLC you get the legal protection of a corporation but then have the option to choose which tax entity to file under, sole proprietorship, partnership, or corporation.

Another consideration, and lots of misinformation, is that filing a business legal structure in Delaware or Nevada is a good idea. This might be great for the people trying to sell you their snake oil, but for the vast majority of small businesses there is no better state to form your business in then the state you domicile in. I will agree that for some businesses forming in other then your own state can be an advantage, it is not so for the vast majority of small businesses. Again, no one can blanketly say that filing in another state is a good idea without taking a close look at the type of business you have and your financial information.

Tying to convince people to form their business in states like Delaware and Nevada has become a big income source for companies in those states who try to sell their sizzle. In too many cases, the only advantage is for these companies to collect hundreds, and in some cases thousands, of dollars for something that has no advantage to you.

So ... when it comes to one of the most critical decisions you will make in business, don’t believe everything you hear. Take the time to investigate your options and if you can’t make a clear factual decision talk to a pro who knows the right questions to ask ... and who doesn’t have an alternative motive by guiding you to a decision that will guild their bank account.

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