Incorporating a Small Business

Why should a new business incorporate, and what sort of legal entities are available? This is a question I hear all the time in my business law practice.

In most cases, using a legal entity to carry on a business makes good sense. It helps protect the personal assets of the individual business owners from creditors of the business and helps provide a mechanism to raise capital to fund the business.

The two legal entities that most people choose from here in Washington are the corporation and the limited liability company (or LLC). The choice always boils down to many factors, not the least of which is tax. Small business owners generally want to minimize taxes, which points to using either a corporation that qualifies for “S-corporation” status or an LLC; both of these entities essentially tax the business operations just once, in the hands of the individual business owners. Individuals can own corporations and LLC’s, and operate their businesses through them as single owners. The LLC is generally considered to be the best entity to use to own real property.

Forming legal entities in Washington is generally pretty straightforward, although where you have a corporation, you have some choices that you should think about during the set-up phase which can have important consequences, such as how you vote for directors, lowering the voting threshold for big decisions, and so on (the standard, downloadable forms typically ignore these).  

Once the entity is formed, additional steps must be taken to confirm that the business owner is also the shareholder or member of the chosen entity and that any existing business assets (or real property) are properly transferred to the entity – this is something that business owners who do their own incorporating often overlook. The new entity must also be registered for federal, state, and local tax purposes.  

Probably the most important document that is often overlooked or not well thought through is the buy-sell agreement, as it is commonly known. This document should always be used where you have more than one business owner. It describes how the entity will be managed, who will provide funding for it, and what happens if an owner wants to sell out (or dies, gets divorced, files bankruptcy, and so on).  

There are many incorporation forms available to consumers. This can be a cost-effective way to set up a new entity, but I would always recommend having a trusted professional review “standard” forms to make sure they work in a specific case.