Forward Thinking: The Legal Considerations of Entity Formation

Whether it’s a LLC, corporation, nonprofit or hybrid, nonprofit and business attorneys know the beginning of the year is the best time for entity formation. In light of this fact, we wanted to highlight some of the key legal aspects of the process that we thought would be helpful whether it be your first or fifty-first company!

Hammer out the Basics
This is the who/what/where/why of the incorporation process. Some of the questions you want to be asking yourself include:
● What will your company be doing? Note: this can be especially tricky when you are deciding between a social enterprise versus nonprofit structure.
● Who will be running your company?
● Will you be a manager or silent partner in the business?
● Where will your business be located? Out of your house or in a commercial building?
● Why are you starting the business? Holding company, new venture, partnership with existing entity, etc.?

What Corporate Structure Suits Your Needs?
Each type of corporate structure comes with its own set of benefits and challenges. Here’s a very basic breakdown of the most popular structures’ pros and cons:

● Pros:
○ Easy to Create,
○ No limit on the number of partners,
○ Flexible allocation of profit, loss and distributions,
○ Favorable tax treatment when liquidated,
○ More control over the business, and
○ The business is not taxed just the individual.

● Cons:
○ Unlimited personal liability,
○ Potential to be held liable for actions of your partner(s),
○ Difficult to dissolve or change ownership without substantial planning,
○ Individual partner’s share of income is subject to self-employment tax.

Limited Liability Company:
● Pros:
○ Limited liability for all members,
○ Unlimited number of number of members,
○ Separate entity from members allows flexibility in operation,
○ Ownership interest can be transferred easily in accords with operating agreement, and
○ No double taxation on profits.
● Cons:
○ Requires a separate tax return

S-Corporation(75 Stockholders or less)
● Pros:
○ Liability protection like C-Corporations,
○ No double taxation of profits,
○ Ownership is easily transferred through the sale of stock,
○ Separate Entity for Stockholders,
○ self-employment tax is not assessed on the entire profit of the business, and
○ the losses can offset Stockholders’ other taxable income.
● Cons:
○ Complex and expensive to maintain,
○ Requires separate tax returns,
○ Regular board meetings,
○ Tracking of Stockholders’ qualifications,
○ Ownership is limited to specific types of entities, and
○ Deductibility of fringe benefits for owners is limited.

● Pros:
○ Developed area of the law,
○ Flexible and various methods available to attract debt and equity financing,
○ No liability for non-active Stockholders,
○ No restrictions in ownership,
○ Ownership transferred easily through sales,
○ Separate entity from Stockholders,
○ Can have ownership interest in any other business entity, and
○ Perpetual Existence
● Cons:
○ Double Taxation of profits
○ Complex to create and maintain,
○ Requires regular board of directors meetings and
○ Requires separate tax returns.

Benefit Corporations and other Social Enterprise Hybrids
● Pros:
○ Limited Liability, and
○ Social Mission Baked into the Company’s mission
● Cons:
○ Relatively underdeveloped area of the law, and
○ Can be complex to create and maintain.

● Pros:
○ Tax Exempt,
○ Limited Liability,
○ Eligibility for private and public grants, and
○ Permission to solicit funds.
● Cons:
○ Must be very careful about the activities you conduct,
○ Founders have limited control,
○ Can be a costly startup cost, and
○ Must keep current with paperwork and informational filings.

Will You Have Employees?
Having employees affects so many different aspects of the incorporation process. Whether it’s compliance with California’s rigorous employment laws or making sure you file the right taxes, having employees may present some challenges at the onset of formation.

If you have any questions or would like to schedule an appointment to start your own business, call the attorneys at (310) 883- 7923 or email us at

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