Business Formation

What is business formation?

While you can typically start selling your product or services right away, there are benefits to formally establishing your company. Business formation is the process of legally establishing a business structure such as an LLC, S Corporation, C Corporation, or sole proprietorship. Properly creating and maintaining a business entity can provide legal protection and tax benefits. Having a legal company makes it easier to build business credit and apply for financing, as most lenders only provide funding to formalized businesses. 

Benefits of using business formation services 

Establishing a business entity involves filing paperwork with the state, paying filing fees, and following certain formalities to maintain the legal structure of the business. You may also be required to create and maintain certain documentation, such as an operating agreement or articles of incorporation and bylaws, appoint a registered agent to receive legal documents for the business, and keep certain records. 

You can set up your business entity yourself with the support of online resources. However, a business formation service can streamline and manage the process so that you can focus on other aspects of your new enterprise. It may also offer other services you may need, such as registered agent or trademark registration services, for additional fees. Formation services don’t always offer legal advice, so it’s best to seek your own counsel for any legal questions surrounding your new business.   

Four types of business organizations 

When you file the paperwork to establish your business, you’ll need to select a business structure. Below, we’ll cover the four most common business structures. Each type has distinct legal, tax, and operational characteristics.   

1. Sole Proprietorship 

Owned and operated by one person, this is the simplest business structure. 

• Ownership: There is a single owner. 
• Liability: Unlimited personal liability; the owner is personally responsible for business debts. 
• Taxation: Income is reported on the owner’s personal tax return (pass-through taxation). 
• Advantages: This type of business is low-cost and simple to set up, and the owner has full control. 
• Disadvantages: With only a single owner, it is harder to raise capital, and personal liability is high. 

2. Limited Liability Company (LLC) 

This is a hybrid entity that offers the limited liability of a corporation with the tax benefits of a partnership or sole proprietorship. 

• Ownership: This type of business is owned by multiple members (individuals, corporations, or other LLCs). 
• Liability: Limited liability; members are not personally liable for business debts. 
• Taxation: LLC owners can elect to be taxed as a corporation, or they can take advantage of pass-through taxation and pay personal income taxes for their share of the business.  
• Advantages: There is limited liability for owners, flexible management options, and pass-through taxation. 
• Disadvantages: This type of business is more complex to set up than a sole proprietorship, and there are various state regulations that must be followed. 

3. S Corporation (S Corp) 

This is a corporation that passes taxes, income, etc. at the shareholder level rather than the corporate level. 

• Ownership: This is capped at 100 shareholders, all of whom must be U.S. citizens or residents. 
• Liability: There is limited liability for shareholders. 
• Taxation: Pass-through taxation; profits are taxed at the shareholder level, not the corporate level. 
• Advantages: These include limited liability, pass-through taxation, and no corporate taxes. 
• Disadvantages: There are strict eligibility requirements (e.g., the number and type of shareholders), more paperwork for registration, and more regulations to follow. 

4. C Corporation (C Corp) 

This is a standard corporation where the business is a separate legal entity from its owners. 

• Ownership: There can be an unlimited number of shareholders. 
• Liability: There is limited liability for shareholders. 
• Taxation: Double taxation; profits are taxed at both the corporate level and again at the shareholder level when distributed as dividends. 
• Advantages: There is limited liability, it’s generally easier to raise capital, and the company can issue stock. 
• Disadvantages: There is double taxation, there are more complex regulations, and it requires detailed record-keeping. 

How to choose the right structure for your business 

There are many factors to consider when choosing a business structure. Some helpful questions you can ask yourself in order to narrow down your options include:  

• Is having control over business decisions very important to you?
• What level of liability are you comfortable with? 
• Would you prefer to split responsibility with another or several other owners? 
• Are you prepared to raise capital for your business? 

From there, you may want to seek counsel to better understand which structure works best for your business. Also, keep in mind that a business formation service can help outline the different requirements for each entity.