3 cases of incorporation

If you’re doing a small web business, you’ll have to deal with taxes and basic corporate law. You’ll probably eventually want a lawyer, but there’s stuff you need to know and do yourself.

One of those things is what legal entity to choose for your business. The IRS needs to know who is earning all that money you’re making off adwords (snark), and everyone else needs to know what rules this business will be operating under.

It’s fine to do this kind of small web business as a sole proprietorship where you may have no special paperwork to do until tax time in the US, and just use your own SSN to identify the business. But then there is no separate corporate entity. Everything, including liabilities, pass through directly to you.

So, for the third time now, I faced the choice of which legal structure to choose for my business. It’s one of those drop-dead boring, but still important decisions you have to make. Here in the US, the basic forms are Sole Proprietorship, General/Limited Partnership, Single-owner LLC, LLC, S Corp, and C Corp. Each form involves different rules (especially for taxes), and different levels of complexity and cost at first, and on an ongoing basis.

What form was chosen each time and why?

Enteraction

In 1996, two high-school buddies and I created a PC-based multiplayer gaming arcade called Enteraction, with the storefront in our hometown of Hollidaysburg, PA. We choose to create a partnership because there were 3 of us, and since we were all fresh out of college, liability wasn’t a major concern. Two of us would be “passive” partners, one “active”.

Some people are fine with verbal agreements, but it’s smarter to be very clear and up front about everything, especially when friendships are at stake. So we went through the trouble to write up and sign a formal partnership agreement (based on a standard template).

The partnership form worked for us through more than a year of operation, and ultimately dissolution of the business. We realized we could pay the bills, but not a reasonable wage for our active partner. The breakup was amicable. An LLC would have also worked well, providing more protection with a little more up-front cost, but as it turns out that investment would have been wasted.

Cosource.com

In 1998, Veriteam, Inc. was formed with the goal of creating a full-fledged, go-big-or-go-home startup. I had been working an employee at a another successful startup (S3, Inc.), and wanted to follow that model. Investors would eventually be involved. So the company was formed as an “S” Corp, which allowed us to have a few sophisticated investors, but also simplified taxation to pass profit and loss through to the owners like an LLC or partnership.

As many startups do, the business totally changed direction at one point and became Cosource.com.

Through those changes, recruiting employees, private investment, and selling the business to a public company, the S corporation structure worked well, and I’d choose it again in the same circumstances.

Leancode

This time around, I’m trying to create something that will start small, get successful, yet stay sane by not having to take on investors or go public. It’s a different kind of business, and the S corporation would introduce cost and complexity that isn’t justified. So Leancode has been incorporated as a single-owner LLC. This form creates a full corporate entity with it’s own EIN (instead of a personal SSN) and some liability protection, while being treated much like a sole proprietorship for tax and other purposes.

Will it ultimely be the right form for what Leancode becomes? We can’t know yet, and the world isn’t going to fall apart if it isn’t — with a little paperwork and some tax filing headaches, a switch of legal entity could be pulled off. But a little footwork up front can avoid troubles later — perhaps at a time when you’re busy doing cool stuff, and can least afford to take your eye off the ball.

I’ll post next on how a lawyer can fit into all this, but if you’re the self-study type, the book I’ve used in the past and would recommend is The Entrepreneur’s Guide to Business Law (the 2nd edition is from 2002, I’d recommend pre-ordering the coming 3rd edition).

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