How To Start & Grow Your Business

Chapter 7: Legal structures

It is very important to explore legal options for incorporating your business. It is not imperative but we do strongly recommend it as incorporating gives you protection from different liabilities. It also is something demanded by investors if you are looking to raise funds for your startup.

You’ve thought through your ideas, sounded out other people and put together your business plan. Now, it’s time to take the next big step – officially registering your business.

no7-businesslegal-color-(1)

Free Bonus Materials: Don’t forget to check out our templates for this book as well as other great material in the bizHUMM Library! Download in our members’ area HERE.

In the first few weeks, you face some big decisions:

  • Should I incorporate?
  • What’s the best structure for my business?
  • How much money do I need to raise?
  • What sort of accounting system do I need?
  • What about insurance coverage?
  • How do I get my office into shape?

First, to get some practical answers to legal issues, read on…

Should I incorporate my business?

The answer is definitely yes. It’s essential for businesses that make or sell products, hire employees or manage shopping carts. And, it provides numerous benefits for small businesses.

Here’s why…
  • Incorporation gives you the best possible protection against liability (being sued and taken to court).
  • It can provide you with tax advantages.
  • The process is easy & affordable; the consequences of not incorporating could be expensive.

The choices can be complex and depend on your personal and business circumstances. We recommend you always seek professional advice from an attorney or an accountant before making final decisions.

Survey of Business Ownership

What are the 5 types of business structures?

There are five different forms of legal structures in the United States. Each has different tax and legal implications. Here they are:

  • C corporation (C Corp)
  • S corporation (S Corp)
  • LLC (Limited Liability Company)
  • Partnership
  • Sole proprietorship
What is a C corporation?

A C corporation is a legal structure normally associated with large businesses, particularly public companies.

  • The company pays taxes on its profits
  • Shareholders pay taxes on the dividends they receive
  • Shareholders can include individuals and organizations
What is an S corporation?

An S corporation is a more suitable structure for small and medium businesses.

  • The company does not pay taxes
  • Taxes are paid by shareholders in proportion to their holdings
  • There are restrictions on who can be a shareholder
What is an LLC?

A Limited Liability Company can take three forms:

  • Sole proprietor
  • Partnership
  • Incorporated

A LLC allows the owner(s) to shield personal assets from business liabilities. The same taxation requirements apply to each of the LLC structures.

  • The company does not pay taxes
  • Taxes are paid by shareholders in proportion to their holdings
What is a partnership?

A partnership is an organization that is owned by two or more shareholders.

  • Taxes are paid by the partners
  • Shareholders work in the business
  • Shareholders may own equal or different proportions of the company
  • The company does not pay taxes
  • Taxes are paid by shareholders in proportion to their holdings
What is a sole proprietorship?

A sole proprietor is an individual who works in the business and owns it exclusively.

  • The company does not pay taxes
  • Taxes are paid by the owner


Provided by DepositPhotos.com
Incorporation is a critical piece of the puzzle

IN THIS CHAPTER, WE ARE OFFERING GENERAL INFORMATION. HOWEVER, THIS DECISION IS VERY IMPORTANT FOR LEGAL, LIABILITY, AND TAX CONSIDERATION. CONSULT WITH YOUR ATTORNEY AND TAX PROFESSIONAL BEFORE MAKING FINAL DECISIONS.

Which type of legal structure is best for my business?

We strongly recommend you incorporate, but you must consider the tax, legal and liability implications carefully before deciding on the best structure.

Here are 5 helpful steps to determine what is the best legal structure for your business:
  1. Decide how much money you will need to raise in the short and long term. This will help you identify the shareholding structure of your company.
  2. Compare the tax implications of different structures. Here’s a simple comparison: Legal Structure Comparison
  3. Consider the type and level of liability you could face. Risks are higher for companies producing or selling products, hiring employees or selling online.
  4. Take professional legal and financial advice from your attorney and accountant for questions about your proposed structure. Make sure you understand the full implications of your choice.
  5. Use a website such as LegalZoom.com to help you quickly and affordably set up your structure.

Tip from an Expert


BWeltman_SM_2Use“Separate your business life from your personal life. This means setting up a separate business bank account and having a separate business credit card. Doing this makes recordkeeping easier, enabling you to know how well (or poorly) your business is doing and to report your income and expenses properly for tax purposes.”

-Barbara Weltman, attorney & author of “J.K. Lasser’s Small Business Taxes”

How many shares should I sell?

One way to raise money for the business is to sell shares to investors. There’s no magic figure to tell you how many shares to sell. It depends on how much money you want to raise and how attractive or valuable the shares are to investors.

Here’s an example:

  • You want to raise $10,000.
  • You decide to issue 20,000 shares for investors.
  • Value per share is the amount of capital you want to raise divided by the number of shares issued.
  • The value of each share in this example is 50 cents.
  • Keep in mind that, as the founder, you can issue shares to yourself at a marginal cost. In the above example, you (and partners) may take 80,000 shares for $0.10 a share, or $8,000. Then go ahead and raise $10,000 for selling just 20,000 shares to investors.

girlwithbook1

Shares authorized and shares outstanding

The total number of shares available is called “shares authorized.”

The number of shares taken up by you and other investors is called “shares outstanding.”

Shareholding and control

How much of the business do you want to own after bringing on investors? The number of shares held by other investors affects your control of the business. Selling more to investors dilutes your ownership as this example shows.

  • You own 60,000 shares yourself.
  • Other investors hold 20,000 shares.
  • The total number of outstanding shares is 80,000.
  • By owning 60,000 out of 80,000 outstanding shares, you control 75% of the business.
  • If you then sell an additional 20,000 shares to investors, you now own 60,000 out of 100,000 outstanding shares.
  • You have diluted your ownership to 60%.

Did you know

If you had bought 100 shares ($2100) in Microsoft in 1986 it would now be worth over $1,000,000 today.

How to determine the original shareholding

Who gets the shares when you first start the business? If you’re on your own, the answer is easy – it’s all yours. But, if you want to bring in partners or investors, what do you offer them?

Here again, no hard and fast rules, but you can apply logic to the situation.

  • You take on a partner and both of you work and put money in equally. Shareholding could be 50% each but remember that with 50/50 partners you will have to arrive at decisions together – amicably is preferred – as no one is the majority owner.
  • You both put in equal money and time but perhaps the idea is yours and you bring greater expertise to the operation. In this case, you may want to consider something like a 60/40 or 70/30 split of ownership in your favor. Again, each situation has to be thought through carefully and reasonably.
  • One more possibility is that you both work equally but you put more money into the company. Because your contribution is greater, you should insist on taking a higher percentage than your partner, perhaps as simple as prorated to your individual investments, if all else seems equal.

This type of arrangement will only work if you and your partners or investors agree and feel good about it.

Demonstrating shareholder value

In our initial example above, you sold 20,000 shares worth 50 cents per share to raise $10,000.

Suppose you subsequently want to raise more money, say $100,000. You now offer to sell shares at $1. How do you justify the increase?

  • Will you give up more control of the business to secure the funds?
  • Will you hold onto your ownership by demonstrating greater value? Maybe the business has progressed with more sales, more skilled people on board or a new website.

Investors will look closely at your offer to determine its value. If it shows good potential for them, you’ve got a deal.

Valuing the company

Part of your pitch to investors is the present and future value you put on the company. Say you’ve developed a product that you feel is going to revolutionize the market. What’s your offer?

  • You offer investors 10% of the company for a $100,000 investment.
  • That puts the value of the company at $1 million.
  • Sounds great on paper – but can you justify it?

In all cases of valuation, small and large, you are going to have to justify your company’s valuation to investors with sound logic, facts and figures.

Large organizations don’t worship shareholders or customers, they worship the past. If it were otherwise, it wouldn’t take a crisis to set a company on a new path.Gary Hamel

Do I need patents?

You may think you’ve just invented the next big thing, but, before you rush to get it patented, take time to consider whether it’s commercially viable.

Patenting is an expensive process and it’s a sobering fact that a high percentage of new products don’t make it past the first year. So, before you hire a patent lawyer costing $5-10,000 and more:

  • Make sure your product is an original idea that can be patented.
  • You may consider taking advice from a reputable organization that assesses inventions.
  • Consider the costs of developing your product and taking it to market.
  • Decide where you want the patents to apply – locally or worldwide.

Forgive our repetition on this point, but, once again, it is so important that you seriously consider all aspects of incorporation and the implications this decision has on potential liabilities and tax implications. Do your homework and consult a professional.