For entrepreneurs, filing the right paperwork for your new company is an important milestone, but also an administrative hurdle. Once your business is formed, another host of very real challenges will arise, such as determining the equity split with your partners, deciding if your business needs insurance, taking office space and more. Determining which formation documents apply to your company largely depends on your business’s structure and the state(s) where your company operates.
To conduct business in a particular state, many owners must first register their company with the Secretary of State in that jurisdiction. Individuals operating a non-registered business put both their personal and business assets at-risk.
Perhaps the biggest challenge is understanding which formation documents apply to your particular business. Formation documents are the forms that must be filed with the state (and sometimes the federal government) to obtain registration – they are, in essence, a contract between you, as the entrepreneur, and the state in which you plan to operate.
Business Structures Generally
New business owners must declare a business structure (also called a business entity) before they can file formation documents and register their business. There are a number of structures to decide from, such as partnerships, corporations, sole proprietorships, non-profit corporations, and limited liability companies (LLCs).
Which structure is best for your particular business? This depends on a multitude of factors, including the type of work or service that your company provides, its risk-level, it’s yearly revenue, and its ownership structure.
Importantly, two principal considerations must be addressed when choosing a structure: asset protection and taxation. According to the U.S. Small Business Association:
“The business structure you choose influences everything from day-to-day operations, to taxes, to how much of your personal assets are at risk. You should choose a business structure that gives you the right balance of legal protections and benefits.”
Owners ultimately want to choose the structure that minimizes their tax burden, while maximizing protection for their personal and business assets. This is certainly an important preliminary decision for any owner; choosing an inappropriate structure can result in over-taxing, the assumption of unnecessary liability, and various (yet avoidable) day-to-day challenges.
Which Formation Documents Should I Use?
Registering your company could be considered a two-step process: 1) a business structure is chosen, then 2) the appropriate documentation is filed to obtain registration. Typically, determining the best business structure is the more difficult of the two steps and many-times requires advice from a business attorney or other qualified professional. Once the appropriate structure has been settled on, all that’s left is filing the correct formation documents.
The formation documents that apply to your company will depend on your business structure and the state in-which you’ll do business. In general, declaring an LLC or Corporation (including non-profit corporations, S corporations, and C corporations) will require more detailed documentation, whereas other types of structures may entail little-to-no paperwork.
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Limited Liability Companies
To form a state-recognized LLC, owners usually need to file the company’s Articles of Formation and Operating Agreement. The articles of formation will include basic company details, like the name of the LLC, information regarding its owners, and its employer identification number (EIN). The operating agreement, on the other hand, essentially sets the ‘ground-rules’ for your LLC, and should establish things like classes of interests, information regarding owners’ rights, general management protocols, terms and conditions for distributions, and procedures for the transfer of company ownership. These two forms essentially work in-conjunction. However, it’s important to consult your state agencies before filing these documents. While most states require the articles of formation, only some will require the operating agreement. States that don’t require a written operating agreement tend to request more in-depth information to be included in the articles of incorporation (it’s simply a matter of state-specific regulations).
Corporations
In terms of incorporating a business, owners commonly must file the Articles of Incorporation, the company Bylaws, and its Shareholders’ Agreement. Here, the articles of incorporation will include things like the company name, shareholders’ information, the purpose of the business, and the number of initial shares. Somewhat analogous to an LLC’s operating agreement, corporate bylaws are the principal organizational document for a corporation and should establish various ‘ground-rules’.
Finally, the shareholders’ agreement will specify how/when dividends are issued, the number of shares to be issued, and the protocol for buying and selling company shares. Importantly, there are many different types of corporations (S Corps, C Corps, Non-Profit Corporations, etc.) and the exact rules regarding formation documents can vary in this regard. Additionally, documentation requirements may differ by state as well. For instance, 15 states—including California and Wisconsin—don’t require corporate bylaws to obtain registration, whereas the majority of states consider bylaws an essential filing. Again, these documents work in-conjunction with one-another, and states that don’t require bylaws frequently request more detailed information in the other formation documents.
Other Business Entity Structures
As stated earlier, LLCs and Corporations are required to submit relatively detailed documentation to register their business (in-fact, these record-keeping responsibilities expand beyond the formation process, as most corporations and LLCs are required to keep well-maintained documentation throughout the company’s lifetime). Other types of structures are typically not held to the same standards. For instance, the formation of a Partnership only requires a standard partnership agreement, as things like bylaws and operating agreements simply don’t apply. Similarly, sole proprietorships require very little documentation. While this sounds far more convenient for owners, it’s important to keep in-mind that these types of business structures aren’t eligible for the asset-protection and taxation benefits that LLCs and corporations receive.
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