How to create your small business LLC or Corporation with host Henry Lopez. 

What is a legal business entity, why do you need one and how do you create it?  Creating and operating your small business under a legal entity, like an LLC or Corporation, can provide you with the best liability protection and tax advantage. On this episode Henry shares information about what is a legal entity, why you need one, and how to create and maintain your small business entity.

Episode Host: Henry Lopez is a serial entrepreneur, small business coach, and the host of this episode of The How of Business podcast show – dedicated to helping you start, run and grow your small business.

Resources:

FREE Downloads: 

• Entity Creation Checklist
• Small Business Startup Checklist

Other Podcast Episodes:

Small Business Start-Up Episodes

You can find other episodes of The How of Business podcast, the best small business podcast, on our Archives page.

Sponsors:

This episode of The How of Business podcast is sponsored by Zinch – fast and easy small business financing.

Special Offer:

Zinch is waiving application fees for The How of Business podcast listeners – a $250 value!
Just visit the Zinch website to learn more.

More about Zinch:

Zinch has been providing fast and convenient financing solutions for small businesses since 2004.

Unexpected expenses can pop up anytime in a small business…
Equipment breakdowns, license and permit fees, customer payment delays, and many other unexpected expenses for which you may not have the cash on hand to cover.
And If you don’t address this cashflow issue quickly, it could make or break your business…as Henry Lopez has shared many times on this podcast, running out cash is one of the top reasons businesses fail.

If you require a loan to cover these unexpected expenses, the traditional loan process is too slow to be of any help.
This is where Zinch comes in as the financing solution you need.

Zinch is a direct lender that makes financing fast, simple, and built around your needs.

If you’re generating over $10,000 in monthly revenue and have been in business for over 6 months, Zinch can fund up to $250,000 in less than two days!
The process is simple and quick – you answer some basic questions about your business and may receive a pre-qualified offer in less than 5 minutes, without affecting your credit.

Once approved, one of Zinch’s loan advisors will review the lending options and help you choose the best one for your business. After signing your loan documents securely online you will receive funds into your bank account within 24 hours! I encourage you to see how much financing you can get with Zinch!

And right now, Zinch is waiving application fees for The How of Business podcast listeners – a $250 value!
Just visit the Zinch website to learn more.

Loans made or arranged pursuant to a California Finance Lenders Law license.

We have received compensation from this sponsor partner. We only accept sponsorships from companies who we believe provide products and services that are valuable for small business owners.

Transcript:

The following is a full transcript of this episode. This transcript was produced by an automated system and may contain some typos.

0:00:15.8 HENRY LOPEZ: Welcome to The How of Business podcast. This is Henry Lopez, and this episode is all about entity creation, legality creation for your small business. What is a legal entity and why do you need one? And how do you go about creating one, because creating and operating your business under a legal entity like an LLC or a corporation can provide you with the best liability protection and tax advantages, so I will share some information about what is illegal and see why do you need one and how to create and maintain your business entity to receive more information about the or business, including the show notes page for this episode, and how you can continue to support my show and receive exclusive content and discounts through a Patreon membership. Just visit the holiness dot com. I also encourage you to please subscribe to my show, so you don’t miss any new episodes, I wanna thank… My listeners are across the United States, and also in countries like Germany, the Philippines, Canada, and Australia, and many other countries around the world. Since I started to show in 2016, my show has now been downloaded over 4 million times, and the show averages over 100000 and monthly listeners, I also wanna thank some recent patron members, Nancy, Cory, Troy, and many other things were joining my Patreon membership.

0:01:32.3 HENRY LOPEZ: I appreciate your support. So let’s talk about entity creation, legal business entity creation for small business owners. I have created an entity creation checklist, which I encourage you to download it as a free download, just go to the show notes page for this episode at TheHowOfBusiness.com and download this entity creation checklist. You don’t need it right now to follow along in this episode, but it could help if you’re at a place where you can do that, otherwise, just be sure to go back to the holiness dot com later and download this checklist before I get into it. I also wanna be clear that of course, I am not a lawyer or a CPA, so what I will share with you on this episode is only based on my experience, knowledge and research, you should always consult with an attorney and a CPA before implementing anything related to legal entities, you should certainly get the advice of your CPA or attorney before you determine the right type of legal entity that’s best for you and your business. So let’s start with what is a legal entity. The legal entity is a legally recognized structure, business structure that separates the Business from its owners and provide it with distinct legal rights and responsibilities, it’s an entity that exists as a separate legal person from its owners, so that word person, obviously not used literally, but in the eyes of the law, it’s considered a separate legal entity, and it allows you to conduct business and Torino contracts, or are there legal agreements, own assets and also be held liable for his actions.

0:03:02.8 HENRY LOPEZ: It’s a separate body, if you will, that exists under the law, which we use to operate a business. Now, what are the different types of legal entities that a business can operate under, the first type, which is really not a separate legal entity, is what’s called Sole Proprietorship, that’s a business owned and operated by a single individual, so you own the business in your name, the owner in the business are not considered separate legal entities, meaning that you as the owner, you assume all the liability for the business debts and obligations. Now, in my experience, and in my opinion, and I think you’ll find in the opinion of a lot of experts, I strongly encourage you to not operate as a sole proprietor, at least not for very long. I certainly have seen situations for independent professional teleprinter where it might make sense for you to operate as a sole proprietorship for a period of time, but I wanna suggest to you and urge you to consider creating a legal entity for yourself. Even if you’re just a one-person operation, so get some advice on that, but I strongly encourage you not to operate as a sole proprietor, even though it’s perfectly level, there’s nothing illegal about operating as a sole proprietor, it just doesn’t give you the protections or advantages that you are afforded, if you operate under a different type of legal entity, like an LLC or a partnership or a corporation, so the next type of entity that I wanna mention is what’s called a partnership, and that’s a business owned by two or more individuals who agree to share profits, the losses, and the management responsibilities of that business partnerships can be general partnerships, limited partnerships or limited liability partnerships, they come in all different types, with varying levels of liability protection for the partners, these types of partnerships are commonly used for professional services business, like a law firm and accounting firm, architectural businesses, medical practices, consulting companies, it’s important to note though that partnerships come in different forms, including general partnerships, limited partnerships, and limited liability partnerships in epi explained a moment ago, each offering different levels of liability protection and management structures.

0:05:19.1 HENRY LOPEZ: So as an entrepreneur, you should carefully consider the goals, the goals that you have, the financial arrangement of your partnership and the legal implications of these different types of partnerships, before you form a partnership, I would get encourage you to seek legal advice so that you make sure that you choose the right type of partnership, if that’s what makes sense for you and your partners. Now, let’s get into the more common types of legal entities that I have used, and I’ve seen most small business owners use, and that’s either a corporation or a limited liability company, an LLC, a corporation. We’ll start with that corporation is a legal entity that is separate from its shareholders, corporations are owned by shareholders and managed by a board of directors and operated by officers, there see the official roles or titles in a corporation, they provide limited liability protection as all entities do by limited, I mean fairly robust protection, but there are exposure points, but let’s call it limited liability protection to shareholders, meaning that your assets as a shareholder are generally shielded from the corporation’s debts or liabilities if the corporation is sued for example, for something that has happened either on a job site, you’re a place of business, there is a level of protection, there are some exceptions, but there’s a level of protection against that liability to you personally as the shareholder, as the owner of that corporation, so that’s a corporation now, limited liability companies, loss have become extremely popular for small business owners, as I stop and think about it right now, all of my businesses are held under an LLC, if you go back about 20 years or probably longer, you might have found that CPAs were not always big fans of LLCs, but that really has evolved, there’s plenty of LLCs that have stood up in court and that have been proven to be just as viable of a legal entity as a corporation, it’s just that there are

0:07:19.1 HENRY LOPEZ: Certain limitations with an LLC. This is the entity that I see most small business owners using now, I’m not giving you advice on that, you really do need to seek the professional advice of a CPA or an attorney to make sure that that is the right fit for you but an LLC, a limited liability company, is a hybrid entity, as they call it, that combines the benefits of a corporation and a partnership, LLCs offer, again, limited liability protection to its owners, and they’re called members or unit holders while providing flexibility in management and tax treatment there’s a lot less administrative components that are required by the law with an LLC, and that’s one of the reasons that people select LLCs over corporations. So the choice of a legal entity depends on factors such as the size of your business, the structure, liability concerns, tax implications, and your long-term goals for that business, each type of legal entity has his advantages and disadvantages in terms of liability protection, taxation, the structure of the management and other legal requirements, every situation really is unique, and it is essential for you before you start your business to consult with a legal and financial professional to understand the specific implications of each legal entity and choose the one that best aligns with your business objectives.

0:08:41.2 HENRY LOPEZ: And provides the desired level of liability protection and flexibility in the business structure. Again, in my personal experience, most of my businesses have been owned under an LLC, but that doesn’t necessarily mean that that’s what’s best for you, let’s talk about why do we need a legal entity. I mentioned a little bit about this as I was talking about moving against you owning a business or operating a business as a sole proprietor, but operating a small business as an LLC or a corporation instead of a sole proprietor offers several primary benefits. And here are some of those key benefits, you have limited liability protection, one of the key advantages of forming an LLC or corporation is that it provides liability protection to the owners, to you as the owner, it’s not full proof, but there’s a tremendous level of protection there this means that the personal assets, your personal assets as an owner are generally protected from business steps from lawsuits as I mentioned, and other liabilities in a sole proprietorship, by contrast, you as a business owner are personally liable for all business obligations, which puts all of your personal assets potentially at risk, and that cannot be understated, the risk there that you are exposed to, especially if you’re in any kind of business where there is a significant level of liability, if you’re going into people’s homes or you’re providing a product where someone might get hurt or injured or they’re coming to your place of business where they might get injured or hurt, those are typically high liability environments, and you have to be very careful and aware of the exposure there, so limited liability protection is one.

0:10:17.0 HENRY LOPEZ: The next one is separation of personal and business finances, so forming an LLC or corporation allows for a clear separation of what’s personal expenses and business from what’s business finances, and so it’s easier to establish separate bank accounts and financial records, and sharing a more organized and transparent financial structure, and a lot of people care about that, including the IRS, this separation simplifies your accounting, your tax reporting, financial management, and it also helps you from co-mingling funds, if you haven’t heard that term before, it’s an important term that we all must be aware of and understand co-mingling of funds can really get us in trouble with government agencies, namely the IRS, because it’s not able to separate what’s personal and what’s business, and that’s a big problem in the is of the IRS as well as of the court. So you want to avoid co-mingling of funds as much as possible, ideally, entirely. Another reason why you wanna operate as a legal entity other than sole proprietorship is credibility and professionalism, so when you operate your business as an LLC or a corporation, it can enhance that perceived credibility and professionalism of your business, a legal entity often conveys a sense of stability and longevity to your customers, your clients, your business partner is a landlord, whoever it is that you need to interact with as part of your business, it can also help to establish trust and attractive investors and other financial opportunities because of that proceed value of operating as a legal entity.

0:13:50.7 HENRY LOPEZ: Another benefit is ease of ownership transfer, so LLCs in corporations offer a lot greater flexibility in transferring ownership and bringing in new partners, so whether it’s through the sale or the transfer of any ownership, interest or shares, it’s easier to transition to business to new owners or investors. Easier to sell the business and facilitate this continuity and growth and opportunity to sell your business to someone else, there are also tax flexibility, so LLCs and corporations may have more tax planning opportunities compared to so proprietor-ships, they can elect different tax structures, such as an S-corporation or a C corporation status, allowing for potential benefits deductions and income splitting strategies, so again, here, you wanna consult with your tax professional and get the advice on How do you… For you in your business situation, how do you maximize your tax advantages specific to your business and then… Lastly, continuity and succession planning. I touched on this already, really when I talked about being able to sell your business, but unlike a sole proprietorship, an LLC or corporation can have perpetual existence, in other words, I can outlive us as the owner, the business can continue to operate, even if one of the owners leaves or passes away.

0:15:08.9 HENRY LOPEZ: This allows for effective succession planning and ensures the continuity of the business. So it’s important to note that specific businesses and considerations may vary depending on the jurisdiction and the unique circumstances of your business, so consulting would legal tax or business professionals is a must here so that you understand the advantages and implications of operating as an LLC or a corporation compared to a sole proprietorship, and to choose the structure of the lines of… Best with your business goals and objectives. So let’s get into the how, how do you create a legal entity and legal entities are managed and created at the state level, first of all, so depending on what state you are or the home state for your business, where most of the operations will be handled out of or where you will be based, if it’s a virtual business, it’s usually… Where are you based? Well, will the home office of the business be… So whatever state that is in, then that’s where you have to create your legal entity, and then you must also submit federal tax returns on that legal entity for that year that you start, so that next year you have to follow a return for that year in which you started your business, you also might need to file a state returns or other fillings…

0:16:25.2 HENRY LOPEZ: Depending on the state that you’re in, for example, in Texas, while there’s not a state income tax, businesses still have to file what’s called a franchise return, even now it’s not a franchise, but it’s a fee that you have to pay the State for you to continue to have an active business registered in that state, again, even if there’s no income tax, I have created a free download for you again, it’s called entity creation checklist, and I encourage you to go to the show notes page for this episode at the holiness dot com and get that free download is gonna take you step by step, it gets 13 steps on how to create your legal entity, and so use that as a guide. Maybe if you’re already in the process, I’ve already done some of it, you might wanna use it to make sure that you’ve remembered every step or that you haven’t forgotten to do one of the key steps and creating your business entity. So here, I’m not gonna go step by step through it, but I’m gonna highlight some of the key things that you’ll find in that checklist, so at the high level, the process is you have to define your business structure, I’ve talked about that, you need to get advice there you need to consult the CPA, an attorney on what’s best for you, LLC corporation, what flavor of a corporation has corpse Corp, that decision needs to be made.

0:17:35.1 HENRY LOPEZ: First then, of course, you have to choose a name, and there’s a lot of steps, a lot of sub-steps to choosing a name, I’ve detailed that all out in this checklist as well as links to episodes that I’ve done on specific topics like on trademarks or determining a name for your business, I’ve got several episodes that I point to in this checklist to help you to learn more, if you need to, then you’re gonna… After you picked the name you’re gonna create, actually create that legal entity at the state level, there’s essentially three options at a high level, the least expensive, but it requires a little bit more knowledge, perhaps, is to do it yourself at the state website. I’ve done this various times in different states, and I have found that most state websites are fairly easy to follow to create the entity yourself in that way, you pay the least amount. And it varies from state to state. I’ve seen anywhere from about 50 bucks to a few hundred at most, so find the State website for your state, take a look at what that looks like, see if it’s very difficult for you or not, and that’s certainly one option, a second option, kind of an in-between option is to use online services like Legal Zoom or end business there, you pay a small fee and they guide you through online the process of submitting the registration for your particular state.

0:18:48.3 HENRY LOPEZ: Now, a word of caution here with those types of sites, they don’t charge much of a fee for the basic service that they’re gonna try to upsell you on a bunch of different things that you probably don’t need… Don’t allow that to happen to you unless you want it, there’s a lot of options that they’re gonna make it seem like they’re required or essential, but they’re not, and then the third most expensive option is to hire a CPA or an attorney to help you with… And to take care of filing for you to create your entity, so those are the three essential options that you have to actually create the entity at the state, and then you’ll wait to give back your official documents, it’s usually pretty quick, and then legally, you’re in business you’ve created an entity. Now, depending on your business, you might need other licenses or permits, for example, when I was in the salon business in the state of Texas is in most states, that’s a regulated business, so I had to get a separate license to operate as a lot. And if the restaurant business, as I’ve been in as well, there you have local health departments either at the county or city level that control that, and so before I can open a restaurant, I have to have health permits.

0:19:54.1 HENRY LOPEZ: So you have to make sure that you’re aware of what those requirements are, again, as CPA can help you with that to determine that, but often you need to do your own research to determine what are their licenses or permits you might need before you can open for business then another technical component is to get an EIN number, an IRS Employer Identification Number, think of this as your social security number for your business, it’s the number from an IRS perspective under which you will conduct all of your business and under which you will file the tax returns for this business at the end of the year, so that’s easy to get… And I’ve got a link to the site. I don’t want you to get confused and going to sites where you have to pay for this because there is no charge for it, it’s done in minutes online at the IRS website, and there’s a link for that in the legal entity creation checklist that you can download at the holiness dot com. So then you’ve got a couple of other steps. You wanna create legal documents, remember, I’ve talked about this before many times, and I’ve got a link to partnership episodes in this download as well, if it’s more than just you or more than this, you and your spouse, you’ve got partners than a critical step is to draft agreed to an execute a formal partnership agreement or by-laws or operating agreement, it’s different things depending on the situation and the type of legal entity.

0:21:13.5 HENRY LOPEZ: The point is that you need to make sure you have those discussions and agree to those terms of before you fund and start the business, not after now putting the money into the bank is kind of the start of things. So kind of the order of things sometimes is a little tricky, do you create the entity first and then draft the operating agreement or partnership agreement? I like to do this first or at least have the general terms agreed to, but certainly nobody puts any money in until you’ve agreed to and executed your shareholder or operating agreement or a partnership agreement, then you’re gonna open bank accounts, so usually what you need to open a business bank account is those papers from the state that you’ve created your legal entity, so the name that’s legal under which you’re going to open those checking accounts, and that EIN number that you get from the IRS, that’s typically what you need, and then some kind of money that you’re gonna put in, ’cause that’s the next step, you have to fund the business, it’s actually something I think people don’t realize is that technically the IRS wants to see that a business is properly funded for it to be treated as a business, so he’s gotta make sure that you put the right amount of money in there so that the business has enough cash to pay its obligations, you probably wanna seek insurance, liability insurance, commercial liability insurance, most businesses need to have some level of insurance, so you wanna consult in an insurance professional to identify the types of insurance policies that best meet your needs from a liability perspective, perhaps workers compensation perspective, so there’s a lot there related to insurance that you need to learn about and make sure that you have…

0:22:49.3 HENRY LOPEZ: If we go back to second to the levels of protection, liability protections, what I look to think of it is you’ve got two umbrellas, if you will, you’ve got the legal entity that if you manage it correctly, gives you a level of liability protection, and then you have insurance, that gives you another layer of protection in the case of a lawsuit or something else that the company does, an error, that’s the two layers that protect you personally, protects your personal assets to some extent from liability, but you have to comply with the laws because if we do something illegal, there is no protection there, you will be held liable personally if we do something illegal or we break the law, and in related to that, we have to maintain compliance. There are certain things that we have to do on an ongoing basis for the life of that legal entity, to continue to have it be a separate legal entity that includes things like filing for taxes and all of the other things that we have to do in the name of that business, not co-mingling funds. As I mentioned already, keeping the money separate, all of those things are important.

0:23:53.2 HENRY LOPEZ: So again, I want you to make a note that the specific steps I’ve outlined here might vary depending on the jurisdiction you’re in or the type of business that you’re in, but that at a high level are the key steps, can download the checklist so that you have all of these steps for you and the links to other episodes if you need or want to learn more about one of these specific steps, so I wanna talk a little bit more because it’s so important, and sometimes we don’t understand this, especially if it’s our first business as to how to manage a legal entity, it requires care and ongoing management, when we operate a small business as an LLC or a corporation, it really is essential to maintain the integrity of the corporate veil, the thing that protects us to some extent, that protects our personal assets from the liabilities of the business, and so to avoid what’s called piercing the corporate veil, in other words, to avoid that a lawsuit against the business doesn’t then go through and affect our assets, affect us personally, we’ve gotta consider various factors… I’ve touched on some of these, but it’s so important to understand as a business owner, first we have to maintain separate finances, as I said, no co-mingling of funds, it’s crucial to keep your personal and business finances separate.

0:25:09.0 HENRY LOPEZ: Now, there are ways, it doesn’t mean that, for example, if I go on a business trip that I can’t put something on my personal card and then be reimbursed by the business… That’s perfectly legal. But you wanna document that. For example, in that scenario, I would, whether I’m the owner or present to the business an expense report and then get reimbursed as a vendor out of the business for that expense, and then it gets accounted for properly in the business and the business financials, and it doesn’t mean that I can’t put more money into the business, but I have to be careful moving money around, sometimes I might… If I pay the mortgage, my personal mortgage out of the business, or I pay business expensive with my personal card, then don’t properly get reimbursed, those are all examples of co-mingling funds that can get us into trouble. Maintaining separate financials is critical, you wanna use a tool like QuickBooks to help you with that, to keep your finances separate, it’s why you want to have a separate business checking account. At a minimum, I touched on adequate capitalization as well, you wanna ensure that your business is adequately capitalized, that you have enough cash in the bank for the business, that you have sufficient funds to meet all of the financial obligations of the business under capitalization, not having enough money to support the operations of the business.

0:26:26.1 HENRY LOPEZ: It can be a red flag to the IRS and also from a liability perspective, that can potentially lead to piercing of the corporate veil, so maintain proper financial records and demonstrate your business has the financial means to operate and to cover its liabilities. If not, if you get to a point where the business can’t, and that’s where you have to either look to shut down the business or declare bankruptcy or whatever else your CPA might advise you to do in that extreme situation, you wanna, as we call it, maintain proper corporate formalities, you need to adhere to the necessary formalities and governance requirements of the legal entity that you select that you’re going to operate under, this might include holding regular meetings and documenting that, maintaining accurate minutes of those meetings and keeping up with required filings and other documentation you need to treat the business as a separate legal entity, it can follow all legal and regulatory obligations, this is again, where your CPA or your tax attorney will help you tremendously, would making sure that you abide by all of these rules… Of course, as I mentioned already, you want to overheat anything fraudulent or unethical when you engage in fraudulent or criminal or an ethical behavior, it can certainly add a minimum, weaken your protection or weaken the protection of that corporate veil, so you wanna maintain transparency, honesty and integrity in your business practices, and again, avoiding mingling of personal and business interests as well as finances is a way that you can avoid that perception, even fraud or misleading your investors, your partners or your customers, insurance also comes into play here, so obtaining appropriate business insurance to cover or against and protect you against potential abilities is essential.

0:28:10.0 HENRY LOPEZ: Liability Insurance was called commercial liability insurance, typically, such as a general insurance or professional policy, or errors and omission policy can help greatly and mitigating the risk and provide an additional layer of protection, as I mentioned, another umbrella of coverage to protect you and your personal assets from the exposures and liabilities of the business, and again, I’ve said it a million times already, you need to seek professional guidance, you need to consult with your legal, accounting or business professional to ensure that you’re taking the necessary steps to maintain that corporate veil. One of the key advantages of having a legal entity and operating the right way under the legal entity, so these professionals can provide you with the guidance on the compliance, the corporate governance, tax planning, which is a big advantage and other aspects of running a business. The right legal way. So I encourage you to download the integration checklist, it has the 13 steps as I mentioned, on how to create a legal entity, and it includes links to other episodes on different topics related to those steps in creating your legal entity for your small business. I also have another download that I’ve released previously that I’ll have on the same show notes page, which is how to start a business that’s a broader higher level checklist on how to start a small business.

0:29:29.2 HENRY LOPEZ: And you might be interested in that as well. I’ve done a whole series of episodes on the legal aspects of business, and you can easily find out on the archives page, so just when you go to the holiness dot-com, on the menu in the top bar, click on podcast and click on archives, and then go into the legal grouping or archive of episodes, and you’ll find a whole series of episodes of The how a business on different legal topics from partnerships to trademarks, to liability protection, you’ll find all of those episodes there on that archive page. So here are my key takeaways from you on this topic of a legal entity, don’t operate your business, at least not for very long, as a sole proprietorship, you’re really exposing yourself there, unnecessarily, operate your small business from day one, if possible, as a separate legal entity. So that you can enjoy the liability protection, even though it is limited, it’s not full proof, but there is a tremendous amount of liability protection and tax advantages, yes, you’ll need to invest a little bit of money to get that proper legal advice upfront. But as I always say, and I give us advice to my clients, If you can’t afford that advice, then you may not be ready to start your business right now, and then simply download the entity creation checklist, come to the houses dot com, the show notes page or this episode and download that free checklist, I wish you the best as you start and grow your successful and profitable small business.

0:30:53.6 HENRY LOPEZ: This is Henry Lopez. Thanks for joining me for this episode of The How of Business podcast. I release new episodes every Monday morning, and you can find a show anywhere you listen to podcasts, including YouTube.