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Benefit Corporation

The Benefits of a Benefit Corporation

Benefit corporations (commonly known as B-Corps) are a relatively new—around a few years now in California—way of organizing your business entity. Designed to balance the for-profit interests of a traditional C-Corporation with the corporate responsibility that all modern businesses should take part in promoting. It’s like a for-profit-non-profit hybrid! Keep in mind, though, you don’t get the tax exemption benefits from the IRS (and your state) like you do with a non-profit.

But why would you want to go with a benefit corporation over a traditional C-Corp, S-Corp, LLC, or even a non-profit?

Before we get into the benefits of B-Corps, let’s briefly discuss how to form one and how they work.

Forming a B-Corp is essentially the same process as forming a normal C-Corp. Articles of incorporation filed with the Secretary of State’s office and you’re good to go. Of course, you can still limit director liability as you can with a regular corporation, but you also have to specify the corporation’s public benefit purpose. Filing fees at the time of this writing are the same for C-Corps and B-Corps.

After formation is where running a B-Corp becomes significantly different from running a traditional business entity. First off, the California B-Corp statutes require transparency in your business. This means you’re mandatorily required to report certain corporate records, generally on your company’s website.

Another big change is that a super-majority (more than just over 50%, generally two-thirds vote) of shareholders is required to modify your B-Corp’s public benefit purpose, and to make other various corporate changes. And if you’re a dissenting minority shareholder, you may actually have the right in certain circumstances to have your shares purchased from you at fair market value.

Benefit corporations are required to provide a reports to shareholders with reports detailing the goings on of the company and how they’re meeting their requirements to further their public benefit.

Finally, because this is a benefit corporation we’re talking about, your company has to advance a general public benefit. This means that your B-Corp must make a positive impact on society and/or the environment. Along those lines, there is a third-party organization, called B Labs, that certifies benefit corporations, providing them with a variety of extra perks upon certification. And that’s the real reason why benefit corporations are great—the perks that come with being a Certified B-Corp and the fact that your company is being used (albeit forced) to do good for society as a whole.

Which leads us to the question of how you choose between a traditional corporate structure, a benefit corporation, or a non-profit.

The main question that I ask my corporate formation clients who have expressed interest in benefit corporations is what they want out of their business. Are they purely interested in making a profit? Are they interested in promoting a public purpose? Or is it a mix between the two—and how weighted to one side or another is it?

On a very basic level, here’s how the answers to those questions tends to group my clients.

If you’re purely interested in making a profit or if you’re starting a technology startup and you know you’re going to be seeking venture capital financing in the near future, stick with the C-Corp (or S-Corp in certain circumstances).

If you’re purely invested in helping society and promoting a public purpose, then form a non-profit.

If you’re somewhere in between, go for the benefit corporation—or the lesser known Flexible Purpose Corporation if you’re in California.

So which type of entity is right for you?

When it all comes down to it and you’re in the process of starting your new company, how do you choose which type of entity to base your company around? The best way is to sit down and have a chat with a business attorney to help you sort out which entity is the best based on what you’re interested in doing. While I’ve provided a few questions above, it really comes down to a lot of nuanced, individualized factors to determine whether a B-Corp is right or an S-Corp is right. And that’s really why talking to an attorney is paramount—you don’t want to find yourself spending the extra money down the road to change your corporate structure.

Norton Law Corporation Blog Etsy Business Trademarks and Corporate Formation

How to Protect Your Etsy Business

The idea for this post came from a couple of different sources. First of all, I’m getting married in just over a month, and my fiancee and I have been ordering quite a few things from the handmade capitol of the world over the last few months. Secondly, I recently read an article a couple weeks back about Urban Outfitters, H&M, and Forever21 allegedly ripping off the designs from a number of artists on Esty—I’d post the link, but I forgot to save it (and in true lawyer fashion, I also can’t really comment on whether those companies engaged in that kind of activity). So I figured, why not make a post on how shop owner on Etsy can best protect themselves not only from liability, but from other companies leaching off of their great ideas and unique designs.

Now, it should be noted that Etsy’s corporate counsel, Hissan Bajwa, wrote a post a year or so ago about the various types of business entities an Esty shop owner could own, but I feel like he may have left out a few things and wanted to go into a little more detail. Keep in mind that everything in this post is merely general advice, and none of it should be considered legal advice since (for most people reading) I’m not your attorney and I’m not basing any of this article on specific, individualized, facts but merely general observations.

The Best Legal Structure for an Etsy Shop Owner

What the best legal structure is for your business is going to be a question for your own personal business attorney. That’s right, you’ll need to evaluate what you’re selling, whether you’re working with anyone else, and what the taxes will be like depending on the type of structure you’re interested in (and that’s also a good question for a CPA, as most good business attorneys will tell you).

Let’s Talk Sole Proprietors

With that said, I’ve been shopping on Etsy for a long time, and I know that for most of the seller out there, who are working part time crafting their wares, a sole proprietorship is fine. You’re doing business as yourself (or under an assumed name, for which you’ll need a “Doing Business As” DBA recorded pursuant to your county’s rules), and as a result, if you run a shop on Etsy, you’re already a sole proprietor. From a tax perspective, you and your business are one in the same, and from a liability perspective, you’re also one in the same—which an lead to you being held personally liable for any lawsuits that may pop up against your business. Do keep in mind that you may be able to protect yourself with liability insurance, but be sure you really know what your policy says.

In short, a sole proprietorship structure is easy to run (all the money just goes to you), easy to maintain (you don’t need any specific filings or documentation except for a DBA), easy to form (automatic as soon as you start doing business), but you need to watch out for the liability problems or you could get seriously burned (you’re personally liable for everything done in the name of your business).

So, in an incredibly general way, I’m going to say that for most Esty sellers, a sole proprietorship is all you need—especially if you’re just starting out and don’t want to invest a bunch of money into a business you’re not sure is going to work—unless you’re selling items that could injure someone, including vintage items, food products, beauty and grooming products, certain types of furniture, or anything that could injure someone.

Partnerships Are Just…Meh

Now, the question when you decide to start working your business with another is whether to form a partnership or one of the more “sophisticated” business structures like a corporation or a limited liability company (LLC). This might just be personal preference talking, but I’m not a fan of the partnership structure unless it’s absolutely necessary (which does happen in very specific circumstances which are way, way outside the scope of this article). Essentially, you and another person enter into a business partnership, at which point I always recommend a partnership agreement—seriously, if you’re partnered with someone and you don’t have a partnership agreement, call an attorney and get one drafted now, this very instant, I’m not kidding—when you start operating the business together.

A partnership is kind of like a sole proprietorship, but for two people. Same as before, they’re easy to run (just split that money as stated in your partnership agreement, or equally if you don’t have a partnership agreement), easy to maintain (again, just file for a DBA and that’s all you’ll need provided you and your partner are still getting along), easy to form (just start doing business with someone else), and as with the sole proprietorship, easy to get totally screwed if someone sues the partnership. And why you may ask? Because in a partnership, both partners are on the hook for the entire amount of any liability the partnership incurs. So if your partnership is sued, and your partner can’t or won’t help pay, you’re going to be stuck holding the bag (though in all fairness, you can try and get the money from her later).

My feeling about partnerships for Etsy store owners is this: if you’re doing enough business that you’re in need of a business partner, skip the partnership, spend the money and form a corporation or an LLC.

Better Liability Protection Comes at the Price of a Corporation or LLC

We come to the last two types of businesses for Etsy shop owners: the corporation and the LLC. Now, there’s only one type of LLC (unless you count LLPs, which are like LLCs and partnerships mashed up and only used in limited circumstances), but there’s a whole slew of corporation types, from C-Corp to S-Corp to B-Corp. We’re going to talk about a few pros and cons of all of them, but a somewhat more detailed study, you may want to check out my other articles on corporations and LLCs.

For a lot of small business owners, the biggest issue I run into with corporations and LLCs is that entrepreneurs don’t like to pay for them. Most of the time, as long as you do yourself a favor and stay away from the non-lawyer legal service providers you see advertised on TV, you’re going to have to shell out around $500 to $1000 to get a corporation or an LLC formed after attorney fees and filing fees with the state you choose to incorporate in. For some business owners, especially Etsy sellers who are just getting started, that’s quite a chunk of change, and you’re probably wondering what you get for that.

What you get for that is a lot more liability protection in case something goes wrong and your business gets sued. This means that if the business is sued, you’re most likely going to be protected. It also means that you have to keep up with a lot more busywork to keep your business going. Extra documents will need to be drafted, meetings will need to be held, a separate set of taxes will need to be done, and so on. But all of that comes with the big perk that if your business is sued, you and your family aren’t going to have to pay for the damages out of pocket if you lose—your business is solely responsible. And because of that big benefit of a corporation or LLC, if you’re selling products that run a higher risk of hurting someone, do yourself a favor and talk to a business attorney (most of us are free to consult with) about whether you should go the corporation route.

On top of the liability protection, some of the corporation types also give you extra benefits. For smaller businesses, I say stay away from the C-Corp structure unless you’re interested in securing some kind of venture capital investment. However, an S-Corp can help you save money on taxes, and a B-Corp can help you save money on certain supplies and other necessaries to keep your business running since having a (Certified) B-Corp shows the world that your businesses takes social responsibility seriously.

Protect Your Handmade Items from the Prying Eyes of the Big Companies

While the first part of this post dealt with how to protect yourself in the face of liability, the second part of this article will deal with how to protect your products from “theft” by the competition. At the outset, it’s important to know that not everything can be protected and a full on, proper protection scheme will cost you a lot more than you’re probably making selling your products on Etsy, but I’ll give you a few hints and tips on how to protect your products without breaking the bank.

Also, every industry has a preferred type of protection, wether it’s copyright, patent, trademark, or trade secret, so I’ll be touching on all types of protection.

Don’t Copy Me…I Have a Copyright

Copyright protection is automatic for things that qualify for it. That’s right, you don’t need to file any paperwork, pay any fees, or anything like that if your items qualify for copyright protection. However, obtaining a copyright for many types of products is simply impossible, and if you want to go after someone for money damages who has copied your work, you’re going to have needed to register your copyrighted item with the Copyright Office arm of the Library of Congress.

So here’s how copyrights come to be. They need to meet two main requirements: originality and fixation in a tangible medium. First, something needs to be original to be copyrighted. It doesn’t have to be super original, just mostly original. Second, it needs to be fixed in a tangible medium. Say what? That just means it has to be more than just an idea, it has to be “touchable” for lack of a better word. There’s also a third requirement: the item can’t be functional.

With the requirements out of the way, let’s talk about a few items currently on Etsy’s front page that may be able to qualify for copyright protection. Jewelry, clothing and accessories, photographs, paintings, furniture, and eyewear. That’s a pretty wide range of products, all of which may be available for copyright protection provided any individual item from a group of items like that is able to meet the requirements for a copyright.

If You’re Trading Goods, You Need a Trademark

Trademark protection is another great way to keep the big companies at bay and protect your products. First things first, I’m a trademark attorney, so I always recommend that if you’re serious about your business, you really need to spend the few hundred dollars to trademark your company’s name. You don’t have to spend extra to trademark a logo or a slogan, but do yourself a favor and trademark the name of your company to give you that extra leverage to fend off competitors who may try to leach off your success. And even if you’re not worried about that, at least have a qualified attorney perform a trademark search to make sure you’re not infringing on the trademark of another. Seriously, I’ve seen it happen before, and a few hundred dollars now can save you tens of thousands later.

With that out of the way, trademarks are designed to protect brands and make sure consumers know where any given item is coming from. Most notably, business owners register trademarks for the name, logo and any slogans used by the business, along with the names they use to brand their products. However, beyond that, certain characteristics of the products themselves may be eligible for trademark protection under what’s known as trade dress. Trade dress extends trademark protection to the decorative, non-functional, non-essential portions of a product, which makes it an excellent way to protect certain types of products. Here’s a few examples of where trademark protection may be applicable: watches, clocks, clothing, jewelry, eyewear, and accessories.

Patents are Patently Expensive

Patents are the third category of intellectual property protection, and to be perfectly honest, they’re way beyond what you’ll likely need as an Etsy shop owner. They’re usually incredibly expensive and take a long time to obtain, and I really don’t recommend patents for most small businesses.

Keep Your Recipes a Secret, a Trade Secret

The final type of protection for your products is trade secret protection. Purveyors of food products, beauty products, and other consumables, its time to listen up. Trade secrets protect the recipes and formulas you use to create your products, but they can also be used to protect things like customer lists, supplier lists, and pretty much anything that makes you different from your competition. The catch? You need to keep your trade secrets a secret. Don’t tell anyone you don’t need to. Make those you do tell sign a non-disclosure agreement. And if you write any of your trade secrets down, keep them under lock and key and only let others see them on a need to know basis.

A Quick Conclusion to a Long Article

At over 2400 words, I think this is the longest article I’ve written on my site, but there was a lot of information to cover and I hope you’ve learned a thing or two about how to protect yourself and your Etsy business. A few things to keep in mind in parting.

Sole proprietorship is probably fine for many Etsy shop owners, but not all, so call an attorney if only for a quick (free chat) about business structures if you’re worried about liability or interested in taking advantage of the perks of a corporation or LLC.

Copyright and trademark protection may be available for your products, but don’t just assume. As far as trademark protection goes, take a look at the (growing) database of common trademark questions for some quick answers on whether your product may be trademarkable. And if you have a product or service to add, let me know and I’ll give you credit for it.

Whether you’re a sole proprietor using a DBA or a full-fledged corporation, trademark your business name, or at least spend the money on a professional trademark search to make sure you’re not infringing on the trademarks of another.

And that wraps it up. Good luck in your endeavor on Etsy and I hope your business continues to grow into a huge success. And if you’re already a shop owner on Etsy, feel free to share your shop in the comments below.

Norton Law Corporation Presents a Post About the Business Documents Your Company, LLC, or Corporation Needs

7 Documents You Need to Keep Your Business Legally Sound

I’m always a little surprised when savvy business owners come to me to make sure their business is operating legally, only to find they’re missing a number of key documents. To be perfectly honest, a lot of the documents only matter if you’re in the process of expanding your business, going to sell your business, looking to take on investors, or you’re going to register your company’s securities with the SEC. But, that being said, if you want to save yourself a lot of headaches (and a lot of money having attorneys fix things that are horribly, horribly broken) before you take those steps towards growth and expansion, and if you want to protect you and your family’s interests in the most comprehensive way possible, it’s always a good idea to make sure your business’s documents are in order sooner rather than later. Without further ado, the documents you’ll need:

  1. Articles or Incorporation / Certificate of Incorporation / Articles of Organization: These documents have many names depending on where they’re being filed and what they’re being filed for, but they all have pretty much the same purpose—to let the Secretary of State (or the equivalent Division of Corporations) know your business is registered as a corporation or a limited liability company (LLC).

    If you’re incorporating your business in California, for example, you’ll need to draft and file the articles of incorporation. There’s a form, but if you hire a half-decent business attorney, they’ll draft you articles that actually apply directly to your business rather than shoehorning you into what the state’s template provides.

    The Certificate of Incorporation is the document you’ll need if you want to incorporate your business in Delaware. It’s very similar to what you might file here in California, with a few tweaks (and a different name). If you’re not sure whether you want to incorporate in Delaware or your home state (not necessarily California), I wrote a nice article on that a few months ago: Why Your Home State May Be the Best Place to Incorporate Your New Business.

    As for the Articles of Organization, that’s the document you’ll file in California to organize your business as an LLC. Of course, there’s also a form for that—and you generally have to use it.

  2. Bylaws / Operating Agreement: As with the documents above, these two documents have different names, but essentially do exactly the same thing. They help you determine the ground rules for how your business is run. Bylaws are used by a corporation (no matter what kind: C-Corp, S-Corp, B-Corp, etc.) to specify such issues as how large the board will be, where the initial office will be located, what powers the officers and directors have, how shares may be transferred, and how shareholders and directors can vote.

    Now, if you’re the sole shareholder of your own private corporation, you’re probably thinking why in the world would I want to spend a few hundred dollars on a document like this when what I say goes. And that’s a fair question, but here’s a fair answer: in some states, you have to submit your bylaws to the Secretary of State/Division of Corporations/Whatever they’re called in your state at the time time you register your corporation. Even if that’s not the case, some banks will want to see your bylaws before you open an account, the professional licensing organization of your state may want to see them if you’re running a professional corporation, investors will definitely want to see them before they send any money your way, and the buyer will want to see the bylaws when it comes time to sell your business.

    Oh, and if you’re passing your corporation on to your kids when you die, the bylaws can help them easily make the transition from your ownership to that of your kids without too many struggles (provided it’s drafted properly). And best of all, if you’re a sole shareholder of your company and you want to protect your family from liability if your company is ever sued, a set of bylaws can go a long way in proving your company is it’s own entity and not just your alter ego.

    For the purpose of this post, an operating agreement is practically the same as the bylaws, except they’re used for LLCs.

  3. Minutes from Meetings: You’re holding regular shareholder/director/member meetings, right? Right? Well, don’t feel too bad if you’re not. There’s a ton of small businesses out there where regular meetings means once every five years. But while you may not think that the minutes from your regular shareholder meetings are that important, in truth, they really can be.

    Here’s the thing. Imagine your business is going along smoothly when all of a sudden someone sues you for some screw up of one of your employees. Maybe they hit someone with the company car while they were en route to the job site. That person has a valid case and sues your company and you. Normally, if the company has caused some kind of wrong, all of the liability rests on them, but there’s a theory in the law called piercing the corporate veil which basically means that if the plaintiff (the person who’s suing you) can show that your company is no more than just your alter ego, they can go after your assets too to satisfy their judgment debt if they win. And here you thought forming a corporation or an LLC totally insulated you from liability.

    But how can you protect yourself from such an attack? Holding regular meetings and keeping records of them. It doesn’t matter if they’re shareholder meetings, board meetings, or member meetings (if you’re operating an LLC), just make sure you have them and make sure they’re properly documented.

  4. Trademark Registration Certificate: Strictly speaking, this isn’t required, but you should really get one. Seriously, you’ll save a lot of money down the road, especially if there’s already someone else using your trademark and you don’t know about it.

    No matter what kind of business you own, your brand is your most valuable asset. I’ve said it before, and I’ll say it again until I’m blue in the face.

    I don’t care if you’re a cruise ship operator with vessels that cost tens or hundreds of millions of dollars—your brand may be just that valuable. After all, when someone is looking for a cruise ship, they’re not going to trust a company they’ve never heard of, they want the Disney cruise experience or the Carnival cruise experience—not the “some guys we’ve never heard of with a huge boat” experience. So spend the money now and trademark your business’s name (and it’s logo too if the logo is really nifty and a part of your brand’s image).

  5. Employment Documents: Planning to hire someone (or a few someones)? You’re going to need employment contracts, an employee handbook, and independent contractor agreements at least. And you’d better make sure you know the difference between an employee and an independent contractor, because if you misclassify someone as a contractor who’s actually an employee, you’re going to be in a world of hurt. And at the very least, make sure you know whether your employees are classified as exempt or non-exempt.

  6. Distributor / Vendor / Service Contracts: From E-Commerce sites to plumbers, everyone needs basic contracts to help them run their business. Whether you’re distributing someone else’s goods or selling your own goods or services, it’s always a good idea to have your agreements properly documented—and that means in writing. Oral agreements, while technically enforceable in court, are always an uphill battle, so put your contracts in writing.

  7. Non-Disclosure Agreements (NDAs): Sharing your business information with others can be a good idea, but having them steal that information for their own uses later can be disastrous. That’s where NDAs come into play, when you’re showing off some aspect of your business to a third party (including your employees and independent contractors), you want to make sure they’re not going to divulge the information they’ve gleaned to another, or worse, use that information to further their own business interests. Just make sure you don’t give one of these to a potential investor (from a legitimate investment firm or VC) or you’ll look like a real novice in the startup and small business world.

After all of that, you’re probably thinking there can’t possibly be any more documents that may come into play during the life of your business—but there are. Copyright licenses, trademark licenses, commercial leases, industrial leases, equipment leases, retail leases, franchise agreements, term sheets, share purchase agreements, merger and acquisition documents, and the list goes on. As you can see, this was by no means meant to be an exhaustive list of what kinds of documents you need for your business, but it should give you a better understanding as to why hiring a business attorney sooner rather than later can save you a lot of headaches down the road. These documents aren’t going to write themselves, and only an attorney (or a very, very, very skilled businessperson) should undertake drafting, revising, and negotiating them.

3 Reasons Why Your Startup Shouldn’t Be An LLC

One of the earliest legal decisions you’ll need to make as the owner of a startup is deciding what type of entity your new company is going to be. Will you choose a C-Corp? An LLC? Something a bit more eccentric, like a B-Corp? There are a number of options out there, and picking the wrong one can spell disaster for someone hoping for a high growth rate fueled by venture funding.

For most startups, there are three different corporate structures to consider: the C-Corp, the S-Corp, and the LLC. The three are primarily differentiated by their tax treatment, but that’s a story for another article, and I have posted an introduction to LLCs and a primer on Corporations before, so check them out if you want to learn more about those entities, how the differ, and what they’re best suited for. Spoiler: the C-Corp is the best entity for a startup.

Now onto the matter at hand. Why are LLCs are terrible for tech startups? There are tons of reasons, but I’ve distilled them down into three.

  1. Investors Don’t Like LLCs. Venture capitalists can be a funny bunch. On the one hand, they’re always trying to discover the next great thing that’s going to turn into a huge success. On the other hand, they’re ultra-conservative (as much as possible, anyway) with their investments. And they have good reason to be—especially those who are investing other peoples’ money. As a result, investors don’t like LLCs because they’re different than the standard C-Corps they’re used to investing in, which means more money must be spent on due diligence, including evaluating each LLC’s unique operating agreement and drafting the often complex LLC documents; the partnership style taxation of most LLCs means some tax-exempt investors can’t invest in LLCs and all investors can still be taxed on the LLC’s income even if they’re not getting a cut of it in any given year (due to reinvestment, etc.); and investors living in other states may have to declare income, and subsequently be taxed on it, in not only the state where they live, but they state where they’ve invested in the LLC. The upshot of this is that because most investors have issues with LLCs, it makes it much more difficult to find investors for your new startup.
  2. Unlike Corporations, LLCs Are Difficult to Manage the Larger They Get. With a C-Corp, where stocks are issued instead of membership interest when someone acquires an equity stake in the business, a corporation can easily manage how its stocks are being distributed. Stocks are simple and easy to manage no matter how many shares are being issued. Instead, with an LLC, the company is left trying to cut the pie into smaller and smaller parts with each new investor, leading to all kinds of tax complications. Also, LLCs are predominantly governed by their individual contracts, and as more investors get on board, the contracts will become longer and more complex, leading to higher legal fees with each new transaction (except for those lawyers who help startups for flat fees).
  3. Taxes, Taxes, Taxes. I’ve already touched on some of the major tax issues, including taxation in states where passive investors reside and where the LLC is located, but tax problems can also arise each and every time a new investor comes in, depending on how they want their preferential treatment structured (liquidation preference, etc.). The tax code also doesn’t recognize LLC membership interest for reduction in capital gains taxes under Section 1202. And to top it all off, when it comes time to sell your company, you’re going to be stuck with taxes and, unlike with a corporation where you can swap the stock of your company for that of the acquirer in certain circumstances in order to help defray those taxes, with an LLC, you’re left hanging out to dry by the tax code with no option but to pony up the cash to pay the tax bill.

So, as the founder of a new startup, what are you to do? The common solution to the problem with LLCs is to just not use them for startups. While ease of operation and need to not follow any of the traditional corporate formalities may seem like a boon for founders in the early stages, the problems with LLCs escalate as they grow. As a result, if you’re bootstrapping your company, you can freely choose any entity you like (though I recommend doing so at the suggestion of your startup attorney and your accountant). But, if you have any desire to raise funding on a large scale down the road, you’re going to want to consider an alternative structure.

For some reason, those who have navigated away from an LLC tend to be drawn towards the S-Corp. Maybe it’s because someone told them they were a great way to protect themselves from taxes and “all the rich people use them” as tax shields, or something like that. And while an S-Corp is certainly better than an LLC in terms of running a startup driven by investor financing, there are still some problems you can run into. Namely, foreign investors and corporations cannot invest in the S-Corp, and as far as growth goes, you’re stuck at a maximum of 75 investors—so much for rapid growth with lots of investors. As a result, if you’re starting out and planning to bootstrap your operation entirely, an S-Corp is a solid choice for your business structure. But if you’re hoping to build the next great startup with a shower of VC money coming your way, think again.

Which leaves us with the C-Corp. The ideal structure upon which your startup should be based. Investors (and their lawyers) are used to them, they’re easy to deal with, there’s a ton of law about how they work, and it just makes sense.

Now, which state should you incorporate in? Delaware? California? Nevada? Your home state?

A Quick Primer on Limited Liability Companies and Partnerships (LLCs & LLPs)

A Limited Liability Company, or LLC, is a far newer type of business entity than a corporation, though they have quickly become the most popular type of business entity around. This rapid growth in popularity is because LLCs combine liability protection afforded by a corporation with a partnership’s lack of strict administrative rules and formalities. And let’s not forget that an LLC can also provide for tax savings as well. While it would be overkill to say you can form an LLC and immediately forget about its required formalities, it is the simplicity of the LLC that has made it hugely popular among small business owners who would much rather be running their business than scheduling shareholder and board meetings.

A Limited Liability Partnership, or LLP, is very similar to the LLC discussed above. In most situations, if you’re considering an LLC versus an LLP, choosing the LLC is the way to go simply because it affords you more options for growth and provides a better business structure overall. However, some states, like California, require certain professionals to form LLPs instead of LLCs for liability purposes. Some professionals, such as attorneys, architects, and accountants, are prevented by state law from organizing as an LLC, and therefore must form an LLP instead.

Photo Courtesy: Manish Prabhune

Choosing Corporation or LLC: The Legal Side of iOS App Development Part III

At this point, you’ve read through Apple’s developer contracts and you’ve decided on an amazing name for your iOS app. But what’s the next step, aside from actually designing and coding your app, of course?

While it is definitely possible to have a single individual, also known in the business world as a sole proprietor, post an app to Apple’s App Store, you’re going to be much better off if you form some kind of business entity before you submit your app. Why? Several reasons—most of which revolve around liability and growth.

But before we get too far ahead of ourselves, we need to ask what is a business entity? It’s kind of a strange phrase, but it’s simply a general term for corporations (both C-Corps and S-Corps), limited liability companies, and partnerships. Which one is right for you is going to be a judgment call you should make after you discuss your situation with other iOS entrepreneurs and a knowledgable business lawyer.

With the general nomenclature out of the way, let’s talk about some specifics. Most small developers like to form LLCs. People talk a lot about the benefits of an LLC (liability protection, electable S-Corp taxation status, lack of corporate formalities). However, there are a number of very significant drawbacks. For example, I’ve discussed this on our site before, but if you’re forming a single-member LLC, you’d better be sure you know what you’re doing—or you could find yourself liable for the debts of your company. And that’s not a position anyone wants to be in. Further, LLCs often have a problem scaling, which is something even the smallest app developer should be concerned with since app development can sometimes be an expensive undertaking and you may want to take on extra investors in exchange for a percentage interest in the company. That said, LLCs are great for a small number of shareholders (called “Members” in the LLC context), but trying to add more members and investors down the road can lead to some major problems. After all, corporations are much better suited to taking on investors than LLCs are.

And that brings us to the corporation. Compared to LLCs, corporations are slightly more costly to set up and require more effort to keep running (in terms of required meetings, corporate minutes, resolutions, etc.). However, if you’re looking for a way to scale your business at some point, setting up your entity as a corporation is the way to go. With the ability to issue a range of stock types to investors, you’ll be in a position to grow in ways you never thought possible.

But what if you’re looking for something in between? You’ve started out and you’re developing your first app, after all. What do you do? Well, we sometimes recommend setting up the LLC first and then converting it to a corporation later. That way you don’t have to worry about all of the corporate formalities at the beginning and you can focus on what you do best—developing your app. Then, after your app is finished and selling like hotcakes on the App Store, you can convert the LLC to a corporation. And to top it all off, you’ll have saved some money to boot.

Next time we’ll discuss the legal ramifications of using third party resources and code in your app—what it means for your development now and in the future.

Photo Courtesy: Thomas Leuthard

3 Problems with Single-Member LLCs and How You Can Easily Solve Them

I help my clients form lots of business entities. While many of them are corporations, LLCs (Limited Liability Company) are, without a doubt, the most popular. It seems everyone these days wants to start their own LLC, and that’s not necessarily a bad thing—but there are drawbacks to having what is known as a single-member LLC.

Before we get into the reasons why a single-member LLC is not necessarily a good thing, we need to go over some of the background on LLCs in general. Time for a history lesson. The LLC was developed as an alternative form of corporate entity from the classic C-Corp, or corporation. Structured based on partnership rules, the LLC is technically just that, a fancy partnership recognized by state law and given added liability protection than what was provided by the typical general partner/limited partner model used by partnerships. If you have an understanding of the difference between partnerships and sole proprietorships, you may see where I’m going with this.

Partnerships all require more than one member. That’s why they’re partnerships, right? You can’t be a partner to yourself. If an LLC is considered to be highly similar to a partnership, then if you’re operating a single-member LLC, it’s like you’re operating a partnership with only one partner—and that’s a no-no. Traditionally, a partnership with only one partner, then, was a sole proprietorship, a type of business entity with undoubtedly the least amount of liability protection you could have. Therefore, if you’re operating an LLC as a single-member LLC, which makes you more like a sole proprietor than a partnership, that means you have less liability protection than if you have an LLC with multiple members. Which, of course, is why I, as a business attorney, always recommend including a second member when forming an LLC. People don’t always listen, but at least we can say we warned them.

OK, so back to the problems with the single-member LLC. Considering the above, we know these types of LLCs have less liability protection than if there were multiple members—but did you know that in some places they’re completely disregarded? Take the IRS, for example. When you register for an EIN (Employment Identification Number), they tell you your LLC will be taxed as a disregarded entity—just like a sole proprietorship. Not like a partnership. Not like a corporation. You have to affirmatively select one of those options. Even more amazingly, some states don’t even allow you to form a single-member LLC. California isn’t one of them, in case you were wondering. Though California will definitely disregard your single-member LLC (and hold you personally liable for damages) if your LLC is ever sued and doesn’t have enough capital to cover the damages if the other party wins.

To recap, the single-member LLC is problematic because it can be so easily disregarded. This means less liability protection, possibly less tax benefits, and the risk of personal liability if your LLC is undercapitalized.

So How Do I Solve This Problem? I Thought My LLC Was Supposed To Protect Me From Liability

The solution is easy: add another member to your LLC. We always recommend a family member, such as your spouse, partner, parent, or child. You don’t have to give them a 50% stake in the company, just a couple percent will do. You still get to make all of the important company decisions while they are just entitled to a very small share of the profits (and losses).

But I Don’t Want To Share!

There’s always those people who feel the’ve built their company by themselves, with their own hard work and capital, and they don’t want to share the membership interest in their LLC with anyone else. A completely valid point that I can definitely accept. If you’re one of those people, just keep in mind that you’re never going to insulate yourself from liability as well as you could by adding another member, but here are a few tips that may help you protect yourself slightly more.

Elect corporate tax treatment with the IRS instead of “disregarded entity” tax treatment that is default with a single-member LLC.

Keep unbelievably perfect records of all meetings and resolutions for your company. Even though you’re only one member, vote on everything. Document all major events. The more records your company keeps, the better.

Never personally sign for any LLC-related purchases or contracts. Always sign your name on behalf of your company.

Never mix money in your personal bank account with your company’s bank account. Keep them totally separate and keep excellent records regarding your LLC’s assets and liabilities.

Use your LLC’s EIN on all tax filings.

So there you have it, some reasons why a single-member LLC is not necessarily the best idea for forming your business entity, and some tips on how to get around the problems it presents.

Photo courtesy: Bob Jagendorf

2 Important Questions To Ask Before Electing S-Corp Status For Your LLC

I’ve been getting a number of questions regarding what’s best for a person’s business. The S-Corp or C-Corp? The LLC? A B-Corp, perhaps? When it all comes down to it, there’s really no perfect answer, and every case has to be looked at on an individualized basis. But one thing is for sure, there are bound to be questions as soon as a client learns about the possibility of electing S-Corp status for their LLC. For some reason, this idea of having an LLC that is treated like an S-Corp is some kind of revelation for our clients who feel like maybe, just maybe, this is a way to dodge the tax man or somehow outsmart the IRS.

While there are a number of important factors to consider, this is a quick blog post—not a one-on-one discussion with a business attorney, accountant, or tax attorney regarding your company. Accordingly, we’ve distilled the numerous factors down to just two of the most important.

  1. What is the Difference Between Electing S-Corp Status and Organizing as an S-Corp? The most important fact to keep in mind when considering an S-Corp election for your LLC is to remember that you are not reorganizing your LLC as an S-Corp—you are simply choosing a different tax treatment. The type of business entity you are organized as is a legal distinction while the type of entity you choose for taxation purposes is a tax distinction. So, if you have a single-member LLC without the S-Corp election, your business will be considered an LLC for legal purposes and a disregarded entity (or sole proprietorship) for tax purposes. Further, if you have a multi-member LLC without S-Corp election, your business will be considered an LLC for legal purposes and a partnership for tax purposes. Finally, no matter how many members your LLC has, if you elect S-Corp status, your business will be considered an LLC for legal purposes and an S-Corp for tax purposes.
  2. What are the Tax Benefits to Electing S-Corp Status? Well, the tax benefits depend on the number of members you currently have in your LLC. Most prominently, for all LLCs, being classified as an S-Corp for tax purposes can mean you no longer have to pay individual self-employment tax, which can turn out to be big savings. However, choosing S-Corp status also reduces your tax flexibility for a multi-member LLC because the partnership style tax status multi-member LLCs enjoy gives the members a lot more leeway. If tax benefits are the main focus of your reason to elect S-Corp status for your LLC, which they should be, you have to consider your individual needs and definitely talk to an accountant before making the election (but always have an attorney draft the necessary formation documents).

Image Courtesy: loop_oh

Why Your Home State May Be the Best Place to Incorporate a New Business

There’s one question I’m asked more often than any other when I’m counseling clients about business formation. What is the best state to incorporate a new business? There are the usual choices, of course. Delaware, Nevada, and Wyoming. These states all provide a number of benefits to the up and coming entrepreneur. Tax perks, rich history of corporate law, extra protections for corporations and the individuals who incorporate them.

But are those states really right for your business?

Any decision about where to form your new business entity obviously has to be made on a case by case basis. As an attorney, I’d be doing you a disservice to tell you that you absolutely must form your corporation or LLC in one particular state because, let’s face it, different business entities need different things and what works well for one company will be exactly the wrong thing for another.

What I can tell you, however, is to consider your home state as a frontrunner along with the usual top three choices. Our law firm is located in California—a state widely regarded to be, shall we say, less than friendly to small businesses. Except for tech startups. California is plenty friendly to those. In any event, California has high taxes, some foolish laws, and some courts have a penchant for trying to hold the officers and directors liable the debts of the business. Aside from all that—its a perfectly good place to incorporate your business.

So you’re a new business owner who wants to form a corporation. Say its a plumbing company. You live in California, you’re licensed in California, your employees all live and work exclusively in California, your shop is in California. You can see where this is going—you’re totally tied to California for your business. But you decide you want to incorporate your business in Delaware because a friend of a friend told you that’s the place to do it. Tax breaks, good law, whatever reason you have. If you decide you want to incorporate in Delaware, you’re going to have to pay for the incorporation there, file all of their paperwork, pay at least their minimum taxes, and so on. But, because you’re operating your business entirely in California, California is going to require you to register as a foreign corporation in California. Why? Because you’re transacting intrastate business here. And you’re going to have to pay for the registration here, file all of the paperwork, pay California’s taxes, and so on.

Sound like a good idea?

I didn’t think so.

That’s just one situation where it may be better to form your new corporate entity in the state where you’re actually conducting business. There are others, but that’s a topic for a one on one conversation with our clients. If you’re considering starting your own business and are looking for an attorney to help walk you through the process from start to finish, give us a call and we can put you on the right track—no matter what state you’re interested in.

Image courtesy: Robert S. Donovan