You’ve started — or have an idea for starting — a business. You’re ready to make it official. How to form a company in the US? Where, exactly, do you begin? This quick guide will get you started.
The very easiest way for anyone to “start a business” is as a sole proprietorship or partnership. These types of businesses typically do not require any paperwork to get started.
The United States also offers 4 different types of corporations: C corporations, S corporations, Limited Liability companies, and nonprofits.
Assessing Legal Structures
Which one is right for you? When weighing your options, what you want to be thinking about is:
- ease of getting started
- cost of starting and maintaining
- tax implications
- legal protection it offers
- fundraising leverage
- ability to add additional business partners and/or equity shareholders
The right legal structure for your business will depend upon your goals for the business. So, as you read through this, consider what’s important to you. And if you haven’t already done so, consider writing down what it is you’d like to accomplish by creating your business as an entity.
Any individual can start a sole proprietorship or partnership without filing legal paperwork (that’s true in both the US and Canada). If I sell goods or services under my name, I’ve essentially started a sole proprietorship. Woohoo! I’m in business.
Tax Implications for Sole Proprietorships in the US
Any income or expenses related to my sole proprietorship need to be reported to the IRS — most likely on IRS Form 1040, Individual Tax Return. That’s the same form you most likely use to do your personal taxes each year anyway. This makes for an easy tax season; but be careful — you’ll want to make sure maintain good records. And avoid mingling personal and business income and expenses.
Because sole proprietorship income is reported as personal income, sole proprietorships are known as “pass through” entities. Any gains or losses are passed through on your personal tax return. Whatever money your business does or doesn’t make is money that you do or don’t make at the end of the year.
Creating a DBA or Fictitious Business Name
Just because I’m running my business as a sole proprietorship doesn’t mean I can’t name it. If I’m making cookies and want to call my business “Erin’s Gourmet Cookies” and start receiving payments made out to Erin’s Gourmet Cookies, I can do that quite simply by filing for a fictitious business name or DBA (doing-business-as). DBAs are also known as Trade Names, or O/As (“Operating As”) in Canada.
Each county in the US handles filing for a fictitious business name a little differently so you’ll want to look up your local requirements. Generally speaking, filing for a DBA should cost you less than $100 and take no more than a few weeks.
Note that DBAs offer no trademark protection. In other words, if someone starts a corporation called Erin’s Gourmet Cookies, I’m out of luck. That said, DBAs are an easy, quick, and affordable way to start operating under a business name.
Note that you can also setup DBAs for LLCs and other business structures, too. At the end of the day, they offer very little legal and trademark protection, so if this is important to you, you’ll want to do more reading on how they work and what benefits they provide.
Here’s where you need to be careful. While operating as a sole proprietorship is easy and affordable, it also provides absolutely no legal protection. If someone eats your cookies, gets sick, and decides to sue your sole proprietorship, they’re essentially suing you.
If you’re serious about growing a food business and selling products that people consume, you’ll want to ensure that in the long term you’ve put good legal protections in place (not to mention insurance policies — we’ll cover that soon as well). But a sole prop is a place to start if you want to get started sooner rather than later, or want to test your idea before investing time and money into forming a corporation.
A partnership is treated much like a sole proprietorship in the US, but allows for two or more people to jointly own a business. A general partnership, like a sole proprietorship, requires no paperwork, and is also treated as a pass-through entity. Like a sole prop, it also offers no real legal protection if someone decides to sue you.
The real benefit to a partnership over a sole proprietorship is that you can have more than one owner — and decide how to allocate ownership percentage.
Corporations have real advantages over sole proprietorships and partnerships. Corporations provide legal protections, alternative tax structures, and more advanced mechanisms for adding multiple partners and allocating equity. In some cases, they’re also a lot more attractive to future investors, if that’s something that’s important to you.
An LLC, or limited liability company is relatively easy to create. It does require an initial application, meaning you’ll need to do some basic paperwork and pay a filing fee. LLCs also require annual filing — in other words, more paperwork, and more fees. (And if you’re late with these, fees on fees.) My annual filing fee for The Food Mint, registered in NC, was $250/year. The Brighthouse, registered in SF, CA, cost $800/year to maintain.
You can use a company like LegalZoom to file for your LLC. You could also hire lawyer to file your articles of incorporation. Most states also make it relatively easy to file the paperwork and pay the fees on your own, which will save you a premium on hiring out the service.
LLC Tax Implications
In the US, depending on whether you choose to be taxed as an individual (LLCs are also “pass-through” organizations) or as an S-Corporation (requires additional paperwork, and the tax benefits on this may be changing), you may or may not need to file taxes for your business separately from your person.
LLCs can be structured to accommodate multiple members (i.e., your business partners and/or investors) and allows you to allocate equity or shares accordingly (i.e., a percentage of ownership). Details regarding ownership and responsibility are typically outlined in what is known as an operating agreement.
LLCs also afford some legal protection; if someone decides to sue you for damages related to the product you’re making, they can only go after the assets of your business. Note that food business owners will still want to get insurance for their businesses. Product liability insurance will provide crucially important additional protection.
Delaware Corporations for Fundraising
If you want to raise venture capital, know that they VCs have a strong preference for Delaware C-Corporations. Why? Because Delaware has the most robust case law for governing C-Corporations. When issues arise, or when it comes time to sell your company, Delaware State Law is going to provide the framework and structure that best protects their interests.
If you think you’ll be bootstrapping your company, raising money from only friends and family, or taking on capital from smaller and less sophisticated companies, an LLC may suffice — but note that most angel investors don’t want to deal with the annual tax paperwork involved in owning shares in an LLC (usually a K1).
Non-profits, or 501c3s, are not likely to be the right legal structure for your food business. Why’s that? You’re likely trying to make a profit — or will need to take on outside capital to scale your business due to your COGS scaling with your revenues.
After weighing your long term goals for the business, you may want to consult with your business partners and advisors, if you have them — and your legal and tax counsel.