Earlier this month, I was given the opportunity to speak with an entrepreneurship class at Purdue University, regularly taught by Tim Peoples – who is also the Director of Entrepreneur Services and Programming for the Purdue Foundry. My goal going into this class was to give the students a basic understanding of the options and processes that go into forming a company.
Why form a company?
I chose to start off the class with this question because it’s important to understand the worth that is created by making the choice to formalize your entity. Through this process you, the entrepreneur, are able to reduce the amount of personal liability you take on, create long term impact that continues past your death, develop strategies to lessen your tax burden, and avoid unintended consequences that can easily be avoided. Having a high-level understanding of the value that can be created is essential before you began to dive into what type of entity you should form.
How do I determine the right type of company?
Once the decision to form a company is made, the founders need to consider what type of entity works best for their business. By far the most important consideration is simple: How can I create the most value for my company as efficiently as possible? In order to answer that question I explore the following:
- What is the client’s anticipated ownership and capital structure?
- What is the best operational structure?
- Are there any pressing tax issues?
- Is there a common industry practice?
- What is the client’s preference?
When working with a start-up I generally advise clients to form as either a C-Corp or a Limited Liability Company (LLC). Without specific company information, some basic reasons a company would chose to form a C-Corp include the ability to avoid pass-through taxations, particular regulatory requirements, and the company’s future plans for bringing in venture capital funds. Another solid option is to choose an LLC. An LLC can be very advantageous for an early stage company as this type of entity is extremely flexible and can easily be converted into a C-Corp without any major tax consequences.
If we do decide to form either an LLC or C-Corp, I will file either Articles of Organization or Articles of Incorporation with the Secretary of State. Once this is completed the entity exists and is legally recognized but the operations of the company are governed by state statutory law. This is not an optimal outcome and for the most part can be disadvantageous to your company if you are not aware of what statutory law states about the operation of your company.
In order to get around this, we will prepare and adopt organizational documents for the company. These documents can include, bylaws or operating agreements, share certificates, property assignments, or buy-sell agreements to name a few. These types of agreements are important for a number of reasons including setting expectations between yourself and other founders and also understanding the structure and processes for your entity.
Finally, once we have registered with the state and adopted important organizational documents, the final step is to take the necessary steps to operate your business. At this point it is important to hold formal meetings, obtain a tax identification number, and open a bank account in the company’s name.
The formation of a business is often the first step towards living out your dream. It is important that entrepreneurs spend time up front educating themselves on the options they have. And, at the end of the day it’s important to remember to keep it simple and to not waste money on things you do not need.
ABOUT THE AUTHOR – CORBEN LEE
Corben Lee is an attorney at Gutwein Law. Prior to receiving his J.D. from the University of Notre Dame, he earned a BS in Management from Purdue University's Krannert School of Management. He focuses primarily on business law.