When should I start a company?

The new year is a great opportunity for new beginnings. Over the past year, there’s a good chance you’ve had time to think deeply about your practice or work on passion projects. As 2021 approaches, you may be asking yourself – How do I know when it’s time to take the next step? When should I start a company? There are lots of factors to consider, so let’s start with the basics.

 The Basics.

 There are 3 main structures for companies:

 Sole Proprietorships: Anyone who operates any kind of business activity without setting up a formal business structure is considered a Sole Proprietor.

 Corporation: A corporation is an artificial entity created by state law, an entity separate from its owners or managers. This limits your personal liability by separating your personal life and assets from your business life.

 Limited Liability Company: An “LLC” combines certain tax benefits of a partnership or sole proprietorship with the limited liability of a corporation.

 One of the biggest advantages to owning a company is capital. Banks and investors are great sources of capital, but they may be hesitant to give money to an individual. Having a full-fledged company shows you not only have a solid foundation already laid, but that  you’ve also put time and research into the best practices for your business.

 Forming a company also protects you from potential risk. Without a company, you, as an individual, are solely responsible for all debts and obligations of the business and actions of your employees. In addition, there’s no protection for your personal assets. Both corporations and LLCs can limit the liability of the owner. 

 Corporations? I’ve Heard of Those!

 A corporation is an entity that is recognized by the state and responsible only for its own debts and obligations. A corporation has a structure that can have multiple members and managers who share the responsibility of running the business. The structure of a corporation protects the managing members from potential risks.

 Unlike a Sole Proprietorship, which will cease to exist when the owner dies or becomes incapable of operating the business, corporations are able to continue in existence forever and you can transfer ownership at any point. In addition, stock (or ownership of the Corporation) may be sold or transferred to others. Corporations make it easy to potentially profit from sales in shares of the company or secure investment in exchange for an ownership stake.  

 Corporations are flexible and convenient, but also come with some downsides. Because a corporation is a state-recognized entity, it must comply with the reporting requirements of the state. State and federal reporting requirements will add to your overall costs to operate.

 And since we’re talking business, we’ll have to talk taxes as well. Corporations are subject to double tax on income. The company owes corporate tax for the net income of the corporation, and individuals owe income tax for any salaries paid or profits taken out, and the company may be subject to other state taxes such as incorporation and franchise taxes.

 Be warned– even if you’ve set up a corporation, it is important to make sure it operates separate from you and your personal life. Creditors can try to “pierce the corporate veil” if your company is just an alter ego of yours (not in a cool way) and you may be held personally responsible for the company’s debts and liabilities.

 LLC - Maybe That’s for Me.

 These days, the most popular option for forming a company is the LLC. The LLC offers the best of both worlds of a sole proprietorship and a corporation. While there are still regulations on state filings and operating the business separate from the individual, the benefits far outweigh the negatives.

 Like a corporation, an LLC limits the liability on the individual and leaves the debts and obligations of the business to the LLC. Raising capital is similar to a corporation, but instead of shares, owners can sell membership interests to other individuals, companies or foreign investors.

 And of course, there is the matter of taxes. Fortunately for the LLC owner, income tax isn’t taxable to the LLC (a pass through entity). That’s because income flows to the individual owners of the LLC and is considered part of their personal income.

 How Do I know it is Time to Start a Company?

 While an accountant and lawyer can advise on the specifics of your particular business, consider these three factors when deciding to form a company:

 Money: Am I making consistent money that would allow me to expand my business? Do I need a loan or investment to take my business to the next level? If the answer to either of these is yes, it may be time to start a company. A company structure can give certain tax benefits to a business that is bringing in enough revenue. And if you need a loan, banks are far more likely to loan to a company than an individual.

 Liability: Is my company a high-risk business? For example, production companies work on busy sets with lots of equipment and often hire project-specific contractors while product manufacturers need risk protection once they start selling to customers. LLCs and Corporations both separate you as an individual from the risk of running your business. Plus, it may be easier to secure necessary insurance policies as a business.

 Team: Am I at the point where I need additional team members? Do I hire project to project? Whether you’re hiring your first employee or your hundredth, having an LLC helps with taxation as well as business dynamics. When you are on your own, you’re the boss, the team, and the support. But if you’re at a juncture where you need extra help, having an LLC can help you to pay salaries, give employee benefits like insurance and profit sharing, and offer equity to those valued team members. Once you pass from a single-person operation to something larger, you may be ready to form a company.