One of the most important and consequential decisions you'll make as an entrepreneur is deciding the form of business your company will take. In this lesson, we're going to talk about the importance of choosing the right business form. We'll go through a few factors to consider when making that decision, and then I'll introduce you to several different forms of business entities. Why is this important? One of the primary reasons getting the right business form is important is legal liability. Depending on how you form your business and the activities that you're engaging under the umbrella of your business, it may impose legal liability for the business itself, but also for you as an individual founder or owner of the business. Making sure that you understand what that legal exposure may be and getting the right business form to help mitigate potential exposure is very important. The other is taxes. Everyone has to pay taxes whether you're an individual or a business. The law treats businesses like people when it comes to things like taxes. Understanding the tax implications for the various business forms is a key component of this decision. Thirdly, financing. The type of business form that you choose will have an impact on the type of financing that you're able to attract to your business. In terms of raising capital and funding for your business, investors and other contributors to capital raising, pay very close attention to the type of company that the business has formed under. So you want to make sure you understand the implications for financing that are associated with the business form you choose. Then finally, having a corporate form or entity for your business helps define clear roles and responsibilities for the company insiders, the people who are participating in the business of the company. Factors to consider when choosing the business form. The first one is personal assets. Why is personal assets important here? First, it's because depending on how you decide to form your company, your individual assets may be subject to satisfying the debts of the company. You want to be very careful about ensuring that your personal assets, your bank accounts, your car, your home, your computer, anything that's personal to you, you want to be sure that you keep those personal assets separate from the assets of your company. You want to have a separate bank account for your company, a separate workstations, separate assets that are the company's assets that are different from your personal assets. Again, that's because if not, you run the risk of having your personal assets be subject to satisfy any obligations that the company may have. Tax strategies. Now, depending on whether you want the business to pay taxes separately or whether you want the taxes to flow through the business to your personal tax returns, all of those decisions dictate which corporate entity form that you decide to make. Either way, you want to make sure that you leverage the most favorable tax strategies for your company. Understanding the tax implications of the various business forms is another factor that you want to take into consideration. Thirdly, what type of investors do you want to attract? Certain types of investors will only do business with certain business forms. Understanding what those factors are, what types of investors are looking for what type of business forms, is an important factor in deciding which form you'll choose. Then finally, cost and equity incentives. Early on in your business, you may not have a lot of capital, you may not have a lot of seed money right now and so you want to make sure that you keep your individual cost down, at least in the early stages of your business development. Different corporate forms will help you mitigate some of the costs associated with that. But also, because you don't have a lot of money starting up, it's very hard to attract talent, good engineers, good employees. You want to attract them through equity incentives. Depending on the business form that you choose, equity incentives may or may not be an option for you to attract good talent. These are factors you want to keep in mind as you go through the process of deciding how you will form your business. I should say a word about clear roles and responsibility here. Because one of the things that is very common with early stage startups in entrepreneurs who are getting their business off the ground is the fog that comes with the early stages of business development. You're thinking about your idea. You're thinking about how do you get your idea in market. You have a lot of different things that are pressing on you, your co-founders, other early investors. Everyone that's in this early stage development is really being pulled in many different directions, and often times this can lead to misunderstanding. It could lead to not communicating roles and responsibilities. I've advised several startups early on in the process. One of the things that has been a common occurrence is the idea that once you form a business entity, whatever form that takes. But once you go through the process of forming the business entity, it helps align the company and the company insiders in a way that really gives clear roles and responsibilities. Who owns the company? Who does what for the company? What equity and incentives do individuals have in the company? By choosing this business form, it allows this clarity of purpose and this focus for the business to really come to the forefront. The idea of going through this process to choose the right business form has these ancillary benefits. Now let's do a quick introduction into the various forms of business. First, partnerships. This sounds familiar to you. You've heard the term partnerships. You may not have heard that there are multiple types of partnerships. You can have a general partnership which is essentially composed of general partners and each of these partners are owners in the partnership. They have control and ownership and management rights in the partnership. You also have limited partnerships. Limited partnerships forms two class of partners. One you have at least one general partner who has ultimate responsibility for the partnership, and then you have a class of limited partners who are running the day-to-day operation of the partnership, they may contribute capital to the partnership, but the general partners, the ultimate person responsible for the partnership. Then you have limited liability partnerships. In most days these are limited to professional organizations like accountants or law firms which allows some limited liability for the partners for these type of professional activities. The next type of corporate form is becoming very popular. Many people are engaging in this type of a corporate form, it's called the limited liability company. This is a hybrid between a corporation and a partnership in that the members, and members is a term that's used for owners in a limited liability company. The members benefit from the benefits of a corporation in the sense that it's a separate entity that has its own operations. They also benefit from shielding their personal assets from liability for the company. That's why we call it a limited liability company. The owners of the LLC are able to get the benefits of the pass-through tax strategies. The taxes are passed through to the members individual tax returns. But if done right, the individual members are not subject to having their personal assets be used to satisfy debts and obligations of the company. Then you have the corporate form, the corporation. There are two flavors of corporations. The most common is what we call the C corp. This is a corporation that is essentially a separate entity. It pays its own taxes. The taxes aren't passed through to the shareholders. It fully shields its shareholders from liability. The obligations of the corporation are borne by the corporation itself. Then the other type of corporation is what we call an S corporation. It requires a special step to register your corporation as an S corporation. An S corporation much like an LLC allows the tax benefits, the tax pass-through, but it also shields the individual shareholders from liability. Then finally, the broadest form of a business entity is a sole proprietorship. That's where an individual is doing business essentially in their own name. This particular business form is not advisable because not only does it keep the tax benefits, the tax is passed through to your individual tax returns. But it essentially is no distinction between the business and the individuals. Any liabilities for the business will be borne by that individual's personal assets. Out of a desire to protect your personal assets and activities from those of the business, sole proprietorship is advisable not to conduct your business under that form. Now, just to wrap up here, this decision or the form of business, because you have tax implications, raising funding applications, legal liability for your personal assets come into play. It's a very big decision, it is very consequential, and you should seek the advice of a lawyer very early on to help you decide what form your business should take. As you're making that decision with your lawyer, you want to consider what impact this may have on your personal assets, taxes, raising capital, as well as attracting good talent for your business. Some of the primary forms of a business entity include corporations, partnerships, LLCs, and finally a sole proprietorship.
