By Claudia Pollak, Esq., Updated October 19, 2020
You’ve got a great idea and a few dollars saved, and are ready to kick off your new venture. As a savvy business person, you know the importance of properly setting up your company from the outset to promote growth and allow the successful implementation of your business plan. Choosing the type of legal entity, filing with the Secretary of State, and taking the corporate formalities needed to operationalize your new company can be confusing and overwhelming, and you realize a strong legal foundation for your company will be critical in attracting clients, employees, and financing. To alleviate some of the confusion, here is a step by step outline of some of the legal actions that should be taken to start your new business on a sound legal footing.
1. Why form a company?
You may ask yourself why you should officially register your company as a corporation or an LLC if you can simply operate as a sole proprietorship, and if so, at what point in the startup process is it most advantageous for founders to take this step?
There are several benefits to officially registering your business with the Secretary of State that will make the relatively low set-up costs more than worthwhile. A legal entity adds credibility to your business by communicating a message of professionalism and permanence to clients, investors, and employees. Additionally, both a corporation and an LLC provide a means of issuing equity to raise capital, allowing investors the certainty of operating within a regulated business environment based on established New York law. But most importantly, forming a company shields the owners from personal liability for certain types of lawsuits and business debts. This can provide protection for your home, cars, and other personal assets and provides you with the peace of mind you need to effectively operate and grow your business. It is important to note that certain types of personal liability cannot be avoided, including liability from professional malpractice, automobile accidents, and other personal torts that are not protected by the corporate form even if committed in the name of the business.
2. Choosing the right legal entity.
The first step to forming your new startup company is to decide on the type of legal entity that is most suitable for your business model and financing needs. Your entity choices include a limited liability company, a business corporation, a not-for-profit corporation, a partnership, and a sole proprietorship.
The entity choice will depend on your goals for the organization and the strategies you will employ to help get you there. For example, if you plan to operate a small business with a few other founders who will all work for the business, a limited liability company may be a useful option. The flexibility in management options, the tax pass-through structure, coupled with the limitation of liability available to the LLC’s members, could make this the best choice for your new venture. On the other hand, a corporate form may be more suitable if you plan to raise funding from venture capitalists or other investors who may expect preferred shares and a corporate model that is more predictable in terms of shareholder rights. If the goal of your organization is to further a charitable mission, forming a not-for-profit corporation may be optimal because it provides a structure for the company to file for federal and state tax exemptions that can free up available revenue to further the company’s charitable mission.
The most significant difference between an LLC and a corporation is their tax status. Limited liability companies are typically taxed as a partnership. Under this approach, unlike a corporation, for tax purposes, the LLC’s profits and losses are attributable directly to the members of the LLC rather than to the company. In a corporation, the corporation’s shareholders are subject to a “double tax” when the corporation pays a corporate tax on its profits and the shareholders then pay an additional tax when the company distributes the earnings as dividends.
Corporations with certain characteristics have the option of electing to be characterized as an “s-corporation” for tax purposes. The s-corporation election allows a company to exist in the corporate form, but with the tax pass-through status of a partnership or LLC. The downside is that S-corporations have restrictions on the number and types of shareholders, which could limit your options for investors. For business owners who also work for the company, s-corporations can offer advantages in that the owners can be treated as employees and be paid a reasonable salary on which FICA taxes are payable. Your tax options and specific situation should be explored with your accountant, who should be an integral member of your start-up team.
Depending on your business goals, there are numerous additional factors that should be weighed in choosing the right form to best operate your new business. An experienced business law attorney can assist you in making these decisions.
3. Choosing the Name.
The name of your business will be important from a marketing and branding perspective. Be sure to choose a name that is available for use, both in terms of the ability to obtain federal trademark protection and to form your company in the state where it operates. Checking the availability of associated website domain names is also critical as website names play an increasingly important role in branding a product or service.
The easiest and cheapest way to determine if your proposed company name is available is to do an online search on several search engines to see what turns up. Look to see whether there are any other companies using a similar or the same name. If so, determine if they are a competitor or operate in a completely different type of business or geographic region that would allay any confusion by the public if you used a similar trademark. You can also do a preliminary federal trademark search at the U.S. Patent and Trademark Office’s website. In addition, you should search on your state’s Secretary of State website to determine whether the company’s planned name is available for use in your state.
4. Forming the Company
Your new company is formed when you file the organizing document, such as the Certificate of Incorporation or Articles of Organization, with the Secretary of State of the state that you will be operating in. If you plan to have offices or operations in multiple states, you will need to qualify to conduct business in these states separately from the state that you are incorporated in. For New York, limited liability companies, New York law requires that new LLCs publish a notice of formation for six consecutive weeks in certain newspapers in the county where the company’s office is located.
Once you file the appropriate formation document with the Secretary of State, your company will be a separate legal entity with its own separate identity. Be sure to carry on business with this in mind to maintain your limitation of liability, including maintaining separate books and records and opening a company bank account to transact all financial business related to the company.
5. Get Your Employer Identification Number
The next step in the startup process is to file the SS4 form with the Internal Revenue Service in order to obtain your company’s employer identification number (EIN). The employer identification number, also known as a federal tax identification number, is used to identify a business entity for purposes of filing its tax return, paying employees, and opening a company bank account.
6. Capitalize on the Company
Your start-up business will need some funds to get off the ground. Initial cash needs can vary widely depending upon the type of business you are creating. Even businesses requiring minimal assets and low operating budgets will need some funds to form and market the company. Big ideas require larger capital infusions, which may necessitate the need for a bank loan or outside investment. The founders should make a reasonable capital investment in consideration of their equity interest in the company, and it may be appropriate to obtain a bank loan for a portion of the company’s needed working capital.
Be sure to deposit any funds you are investing to capitalize your company directly into a dedicated company bank account and to pay the company’s expenses from this account. If the company requires additional funds, you can make a loan to the company, but this should be documented to maintain proper legal separation between you and your business.
7. Corporate Formalities and Organizational Documents
Companies have governing documents that provide the operating rules and procedures, such as when board meetings will be held, notice requirements for shareholders’ meetings, and company indemnification obligations. The necessary organizational documents for New York corporations include the Certificate of Incorporation, the Bylaws, the Instrument of Incorporator, and approvals by the board of directors. The documents for limited liability companies in New York include the Articles of Organization, the Limited Liability Company Agreement (i.e. the Operating Agreement), and the Manager or Member’s Consent.
The first meeting of the governing board is used as the vehicle to approve certain actions, such as the issuance of equity, the appointment of officers, approval of standard banking resolutions, the engagement of an accountant and legal counsel, and the leasing of office space. All major corporate actions should be documented in the minutes of a meeting or in a written consent signed by the members of the governing board. Adopting these documents and corporate formalities will help your company distinguish itself from the actions of its individual owners in order to maintain legal separation for contractual and taxation purposes.
New businesses are exposed to unique risks that must be effectively managed to protect the company and its future. A start-up business has different needs than an established company and its risk management plan should be reassessed as the business grows. Certain types of business insurance are required by law, depending on the type of business and where it is located. For example, every state requires that businesses with employees have workers’ compensation insurance, and some locales may require liability or other insurance. Investors and banks may require a minimum level of insurance to be eligible to receive funding and many clients will expect a minimum level of coverage. Talk to an insurance broker about your company’s specific requirements.
9. State and Local Licenses and Permits
Many types of businesses are required to be licensed by a state or municipal licensing agency. It’s important to check the appropriate licensing authorities to familiarize yourself with any licensing requirements applicable to your business and locale.
Setting up your new business properly from the outset will create a strong foundation on which your company can grow and prosper. Hiring an experienced corporate attorney to guide you through the start-up phase can help you achieve your goals and reach the success you’ve dreamed about. Contact Claudia Pollak Law by calling (201)265-1849 for a free consultation today.