Investing some time and money when setting up a business can help you avoid more expensive problems down the line.
“Clients will want to form a corporation in Nevada because someone told them there’s no tax there. But if they’re doing business in California or elsewhere, generally they have to qualify as a foreign corporation and pay taxes and regulatory fees when they could have just incorporated in California,” says Tim M. Agajanian, a partner at Ropers, Majeski, Kohn & Bentley PC. “It’s important to know what your personal and business goals are and where the best location is for your business.”
Smart Business spoke with Agajanian about steps owners can take when forming businesses that will reduce the potential for future problems.
How should an owner select the entity type for the business?
Sit down with your attorney and talk about the core of the business, your goals and the best locations for your business operations. An accounting firm should also be involved, preferably one with experience in your industry.
Together, you should determine
what entity type to be, based on the kind of business performed; and the accounting, tax and legal issues that would serve as the basis of selecting a state for incorporation or other selected business entity (i.e., general partnership, limited liability company, limited partnership).If you’ve thought
about an exit strategy, that would affect your selected entity and where you would form that selected entity. Some companies are set up to go public eventually while others might be designed for sale to private equity firms or to remain in the family. If you’re not sure, your professional advisers can walk you through this process. It’s really about getting back to the fundamentals of your business and the related corporate and tax laws, regulations and estate issues.What can happen if you chose the wrong entity type?
For example, if you are set up as a C corporation and should have been an S corporation, there are tax issues involved when it comes to sale and personal taxes. I have seen companies that were converted to S-corps to take advantage of more favorable tax structure, and owners had to delay a potential sale of their business while that conversion was effective. It can take years to fully convert from a C-Corp to an S-Corp.
Right now, a limited liability company (LLC) is a popular setup because the administration is easy. But it’s not always the right vehicle. It works well for smaller operations such as family-owned businesses or ownership of certain types of real estate. But I’ve seen it become problematic with larger businesses that have issues regarding corporate governance.
If you’re a restaurant group with five locations, I’d look at a more formal corporate structure because there is more protection of shareholders. Another trend is to incorporate in a state like Nevada, which doesn’t have state income tax. But a business must have a legitimate reason to be there. I can’t tell you how often I’ve taken over representation and asked a client why they’re a Nevada corporation when they’re located in California. If you’re going to pay tax in California anyway, why aren’t you a California corporation or a LLC?
What do business owners need to consider before leasing space?
Look at where you need to be and get a good real estate broker who knows the area to represent you, particularly for professional service companies. The broker can determine what the market is and what landlords are willing to give, and also connect you with the best attorneys who have done multiple deals with that landlord. Some landlords require a personal guarantee from partners of a law firm, while others will treat it like a corporation, so there’s no recourse if they default on the note beyond the initial guarantee.
That’s nuanced protection you would not know about without local knowledge. Avoiding future problems with your business is really about attention to fundamentals, meeting with your attorney and making sure that person knows what is important to you so he or she can identify what issues need to be addressed from a legal and practical standpoint. ●
Tim M. Agajanian is a Partner with Ropers, Majeski, Kohn & Bentley PC. Reach him at (213) 312-2010 or [email protected]
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