Form Business Entity
There is rarely a perfect time to start a business, so you may feel unprepared, but if you have followed the guide and prepared as much as possible, it is likely time for you to start your business. After you have completed the necessary steps to form a startup, it’s time to create your actual startup entity by establishing a corporate structure. Using your best judgment and KPIs, you can select a launch date that is in line with your strategy, goals, and market knowledge.
Most startups do not launch with their ideal offerings, but the Lean Startup Method teaches that it is important to fail fast and pivot. Knowing that your minimum viable product (MVP) is not meeting all your desired specifications does not necessarily indicate that you should wait to launch.
Instead, we recommend you bring in your early adopters to the development process, however you choose to do so, to ensure you are delivering true value to your target clients.
Establishing a corporate structure is critical to the operations and protection of the organization and its founders. Though you are not required to create an entity in order to sell something, specific and intentional entity creation can help you streamline processes and ensure founders are aware of and protected from liabilities. However, if you choose to run a sole proprietorship, understand that you are not required to make any filings, but you are responsible and liable for both the assets and debts of the organization. Keep reading to learn about entities and their formation.
Form Your Company
Starting your company can be daunting, but there are some things you can do to decrease risk. The first is to discuss ownership and structure ASAP. If you are a sole proprietor, you may not have issues with this. However, if you are part of a partnership, LLC, or corporation, you should discuss ownership prior to incorporation. We suggest discussing financial, legal, and logistical topics like seeking dilutive vs. non-dilutive funding, personal ownership shares and contributions, roles within the organization, the desired exit strategy and goals, and any other aspects that may impact the business. Though these conversations can be challenging, it is much easier to resolve disputes before the formation of the entity than in the middle of the launching and growth stages.
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Startups can be formed under different business entities recognized by law. While there are many options available to legally form the business, the three most common entities for technology-driven startups are C-Corporations, Limited Liability Corporations (LLCs), and S-Corporations.
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Each of these entities is governed by different rules regarding taxation, ownership, fundraising, governance, and employee compensation. It is critical for startups to consult an attorney who has experience advising startups prior to deciding a business entity type. The following chart illustrates the different types of business entities and their characteristics.
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Entities and Legal Formation of Business developed by Weibling Entrepreneurship Clinic at the University of Nebraska College of Law. For more information, contact the clinic at eclinic@unl.edu.
Corporate Structures
Sole Proprietorship
Partnership
C-Corporation
S-Corporation
LLC
Owners
One individual called the owner.
Two or more individuals called partners. Must be carrying on a business together for profit.
One or more individuals called stockholders or shareholders.
At least 1 but no more than 100 individuals called stockholders or shareholders. All must be U.S. citizens or permanent U.S. residents.
One or more individuals called Members. Multi-member LLCs have more than one Member. Single Member LLCs have one Member.
Ownership
Business and owner are one and the same. Owner owns all of the business and its assets.
Partnership interests are equal shares by statute unless otherwise agreed in a Partnership Agreement.
Shares of company stock typically evidenced by stock certificates. Can have multiple classes of stock with different rights and powers.
Shares of company stock typically evidenced by stock certificates. Can only have one class of stock (preferred shares not permitted)
Membership Interest expressed as a percentage or as units. Number of units or interest percentage set forth in an Operating Agreement.
Management
Owner manages and controls all aspects of business.
Management and control shared equally by all partners unless otherwise agreed in a Partnership Agreement. Governing document os the Partnership Agreement, whether in writing or orally agreed.
Centralized in a Board of Directors elected by the shareholders. Board can delegate authority to Officers. Shareholders vote on major decisions. Governing documents are the Articles of Incorporation and Bylaws.
Centralized in a Board of Directors elected by the shareholders. Board can delegate authority to Officers. Shareholders vote on major decisions. Governing documents are the Articles of Incorporation and Bylaws.
Flexible. Either:
(1) Manager-managed, where elected managers make day-to-day decisions; or (2) Member-managed, where all the members vote on decisions. Governing document is the Operating Agreement.
Taxes
Disregarded Entity
Owner simply reports all profits and losses on personal tax return. Owner is responsible for paying self-employment tax.
Pass-Through Tax
Partnership does not pay tax; tax partners pay taxes on their respective share of profits. Each partner is responsible for paying self-employment tax. “Phantom tax” can occur if the business retains or reinvests its income.
Double Taxation
Corporation pays taxes on all profits. Shareholders must also pay personal income tax on any distributions they receive.
Pass-Through Tax
Corporation does not pay tax; shareholders pay taxes on their respective share of the corporation profits. Each partner is responsible for paying their own self-employment tax. Can designate a reasonable portion as salary as subject to employment tax with the rest as income on investment. “Phantom Tax” can occur if the business retains or reinvests its income.
“Check the Box”
Taxed the same as sole proprietorship (if one owner) or partnership (two or more owners). May elect instead to be taxed like an S-Corporation or C-Corporation.
Liability
No Liability Protection
The owner is personally liable for all business debts and claims.
No Liability Protection
All partners are jointly and severally liable. Each partner can be sued for all the business debts and all other partnership are liable to contribute.
Limited Liability
Stockholder liability is limited to the capital they contributed. They are not personally liable for business obligations. Exception: Piercing the Corporate Veil.
Limited Liability
Stockholder liability is limited to the capital they contributed. They are not personally liable for business obligations. Exception: Piercing the Corporate Veil.
Limited Liability
Member liability is limited to the capital they contributed. They are not personally liable for business obligations. Exception: Piercing the Corporate Veil.
Formation
Formation is automatic- no filings or documents are required. Mat register trade name with the Secretary of State.
Formation is automatic – no filings or documents required. Automatic if doing business for profit with another individual. May draft a partnership agreement and register trade name with Secretary of State.
File Articles of Incorporation with the Secretary of State. Publish Notice of Organization in the newspaper. Make biennial filings to the Secretary of State. Draft Bylaws.
File Articles of Incorporation with the Secretary of State. Publish Notice of Organization in the newspaper. Make biennial filings to the Secretary of State. Draft Bylaws. File IRS Form 2553 to make S-Corporation election.
File Certificate of Organization with Secretary of State. Publish Notice of Organization in the Newspaper. Make biennial filings to the Secretary of State. Draft an Operating Agreement.
Other Considerations
Strict structural rules and more regulated than other business forms. Investors more likely to invest in C-Corporations than other entity forms.
Strict structural rules and more regulated than other business forms.
To learn how to incorporate in the state of Nebraska, click this link. Here, you can find links, resources, and checklists to help you form/incorporate in Nebraska. This resource is intended for for-profit businesses but does include some resources for nonprofits.