Stellar Formation is a website that helps you create the legal entity of your company.
From choosing the right type of company, to splitting equity, getting your EIN and paying taxes - our experts guide you and handle the tough parts, so you can get down to business. Our mission is to make the hard legal process of forming your company easy, educational and fast.
We are a team of tech experts and top NYC lawyers, combining years of experience forming companies. Join the 100+ companies we’ve already formed across the country. Spencer Wolff is a Partner - Lawyer in Stellar Formation.
How to Start a Company, The Four Types of Firms:
So you’ve got a business in mind, and you want to start forming your company. Setting up a company is not something to be taken lightly. How you create your company can mean the difference between millions of dollars in legal fees and taxes, or millions of dollars in investment and profit. That is why it is important to know how founders can go about limiting their liability and start their company. Below, we’ve highlighted the most important things to know about Sole Proprietorships, Partnerships, Limited Liability Companies, and Corporations. Here at www.stellarformation.com, we can help you form your Limited Liability Company in Delaware and New York, or form your Corporation in Delaware.
What is a Sole Proprietorship or Partnership:
A sole proprietorship is an unincorporated business owned and operated by one person. It is normally operated with few if any employees. Sole Proprietorships make up the vast majority of businesses in the United States, approximately 70% of all businesses in 2013. That said, Sole Proprietorships only generate about 5% of total U.S. revenue. Compare this with corporations, which make up only 19% of firms, but are responsible for 84% of all U.S. revenue.
Setting Up A Sole Proprietorship:
“Buyer Beware”, while there are hundreds of online websites which purport to sell Sole Proprietorship formation kits, no formal action is required to set up a sole proprietorship. Rather, if you are conducting business activities, as the owner, you are a sole proprietor. That said, it is important to look into your state and local laws to see what sort of business licenses or permits may be required for your business.
Taxes and Liability:
For a “Sole Proprietor” there is no separation between the business and the owner, so the business is not taxed separately. Rather, your entrepreneurial profits, no matter how large or small, are considered personal income – sole proprietorship income is your income. That may sound like a breath of fresh air if you’re filing your own taxes, but what if something happens?
The owner of a sole proprietorship has unlimited personal liability for all of the company’s debts. That means that if you default on any aspect of your business, get sued, or one of your employees is injured, the lender, debt collector or lawyer can (and will) require you, the owner, to pay the cost from your personal assets, often resulting in personal bankruptcy filings.
Partnerships are identical to sole proprietorships, except that they have more than one owner. That is why we put these two formation types together. Like sole proprietorships, all partners are liable for their company’s debt. Any lender can require any partner to repay all of a company’s outstanding debts.
One exception to general liability in partnerships is the limited partnership. In a limited partnership, there are two types of partners: A general partner who is personally liable for all the company’s debt obligation, and limited partners, whose liability is limited to their investment.
In short, we understand the allure of a sole proprietorship and partnerships. The upfront costs are minimal, and when creating a business, costs can be the most important aspect. However, for most businesses, the disadvantages of being a sole proprietorship or in a partnership outweigh the advantages. All the risk of things going wrong is born by either the sole proprietor or the partners. Not only do accidents always happen at some point, but America is a very litigious society. Even if you do everything right, you may find yourself at the wrong end of an angry lawsuit from a dissatisfied client, disgruntled employee or supplier.
As soon as you’re ready to borrow money to finance your business or wish to release yourself from personal liability, it is time to consider other forms of businesses, specifically a limited liability company or a corporation.
What is an LLC?
A Limited Liability Company (“LLC”) is a limited partnership. That is, all the owners have limited liability, but unlike limited partners in the partnership model, they can also run the business! In Germany LLC’s are known as Gesellschaft mit beschrankter Haftung (Germany). In France, they are called or Societe à responsabilite limitee. LLC’s in the United States make up about 6% of all businesses and similarly account for about 6% of all United States business revenue.
Typically at Stellar Formation, we recommend LLC’s for companies who sell more traditional products and expect to grow organically and not raise outside funds to scale. LLC’s are great, especially in New York and Delaware (more on this later), because they provide all the protection of limited liability while affording the “owners”, which in the case of an LLC are referred to as “members”, the operational flexibility of a partnership.
Setting Up An LLC.
The formation process for an LLC depends on the state. Typically, a formation of an LLC requires that you choose a business name, file articles of organization, create an operating agreement, and in some states, including New York (but not Delaware), pay a publishing fee*.
*For many formation services, publishing fees are hidden fees tacked on at the end. At Stellar Formation, we clearly list the cost of each item related to LLC formation for New York State and Delaware. We even include equity split agreements, and intellectual property documentation so you and your partners are protected. We hate hidden fees, and so should you.*
Almost anyone can start a United States LLC, even foreigners. In fact, there is no federal or even state law that requires an LLC member to be a United States citizen or even a permanent resident. You can form your LLC from the United States or from another country.
LLC’s are a simple and cheap formation for taxation purposes. Like sole proprietorships and partnerships, the federal government does not consider LLC’s as a separate tax entity. LLC’s are known as “pass through entities”, which means that their earnings just pass through to the personal income taxes of their members. This means accountants do not have to file a separate tax form for the company, which also saves on costs down the road.
We believe that LLC’s are great for companies that are concerned about the cost of formation, taxation, and their latitude to contract freely within their organization. LLC’s are a great fit for entrepreneurs, consultants, and freelancers for those reasons. As a business, your clients do not care if you are an LLC or a Corporation. In short, unless you have intentions of raising investment rounds in the future, it might be best to start your business as an LLC, and later, considering converting it into a Corporation or an S-Corporation.
What is a Corporation:
It’s alive! Really. A corporation is a legally defined entity, completely separate from its owners. A corporation enjoys many of the same rights and responsibilities that an individual or sole proprietor does, including the right to enter into contracts, loan and borrow money, hire employees, and of course, pay its own taxes. This also means that the corporation itself, not the shareholders, is legally liable for the actions and debts that it incurs. As a result, the shareholders of a corporation are not liable for any obligations the corporation enters into. Alternatively, the corporation is not liable for any of the personal obligations of its shareholders.
At Stellar Formation, we normally recommend corporations for companies who expect to seek investors to scale up their business and go through several rounds of financing; i.e. the traditional startup model. Corporations are better for investors because investors can passively hold shares without having to worry about tax consequences until they sell them again sometime down the road. The downside of corporations is that they are taxed at a higher rate than LLC’s and they require separate filings with the IRS, which means added accountant bills. However, they are the gold standard of the business and investment world and there are lots of ways to reduce your taxes with a good accountant.
95% of Corporations in the United States are Delaware Corporations, thanks in part to the corporation formation services offered at Stellar Formations. Delaware has a particularly attractive legal environment for setting up corporations, so many businesses and startups chose to incorporate in Delaware. In fact, since the volume of incorporations in Delaware is so high, the legal fees for taking in investments and setting up stock options and other employee plans are a lot lower because lawyers and investors already know the law and have good templates to work from. As a result, negotiations with investors are quicker, and funding comes easier.
Setting Up a Corporation:
Like an LLC, a corporation is formed under the laws of the state in which it is registered. Most states require at a minimum that you register your business name and file certain documents with the State Division of Corporations, including the articles of incorporation. If you’re planning on having your corporation employ people and pay taxes, it is important that after registering with the Secretary of State Division of Corporations, you obtain an EIN number for your corporation, which is separate from your own SSN.
Since corporations are their own entities, most states require an elected CEO or President and a Secretary, to oversee the company operations. In Delaware, the law requires that each corporation have a CEO or President and a Secretary. However, one person can fill more than one role.
In early stage startups, the Founders usually both sit on the Board and act as the officers that run the day-to-day business of the company. However, as the company grows and brings on investors, outside directors will likely be appointed to the board.
Here’s a typical setup for a two founder startups:
• Kenneth, Director and CEO
• Max, Director and Secretary
At Stellar Formations, our experienced attorneys will take care of: filings, obtaining a Delaware registered agent, drafting your company bylaws, equity agreements, intellectual property agreements, and EIN creation so the process of setting up your Delaware Corporation is flawless.
Because a corporation is a separate legal entity, a corporation’s profits are subject to taxation separate from its owner’s tax obligations, effectively making the shareholders pay double tax. Tax, in this case, is paid on the profits that the company accrues, and again when dividends are paid to shareholders on their personal tax returns.
For example, my corporation makes $10 per share before taxes. After my company pays its taxes, it will distribute the rest of its earnings to me, as a dividend. Yay! Not so fast though. The corporate tax rate is 40%, and my tax rate on dividend income is 15%. How much of the earnings remain after all my taxes are paid?
At $10 a share, with a 40% tax rate, my corporation will pay $4 to the government in corporate taxes leaving me with $6. I need to pay 15% on that $6, which is $0.90. Now I have a take home earning of just $5.10 of the original $10 earned, and I effectively just paid 49% tax! Yikes.
However, you should know that last year 50% of corporations paid no taxes at all! How is that possible? Well, many corporations practice what is known as zeroing-out. Zeroing-out means your corporation pays out all of its earnings in salary and bonuses to the founders, or reinvest the profits into the business again. Even if it seems like a lot of taxes, there are a number of creative and LEGAL ways to reduce your tax burden and run a successful corporation. That’s why 95% of US companies are corporations.
Forming your business as a corporation is a great way to attract outside investment and generate capital. Corporations have an advantage over LLC’s and other forms of businesses—the ability to raise funds through the sale of stock. But be wary of the costs associated with additional paperwork. Corporations are highly regulated by federal, state and even local agencies, which results in increased paperwork and recordkeeping burdens, in addition to double taxation. Nonetheless, if you want to scale, build a record-breaking company, or someday sell shares in your venture, choose a Corporation for your company. And choose Stellar Formations to set it up.