If you’ve been reading this 30 Days to ETA series, you know that in the Day #10 post I stressed the importance of creating an ETA Culture (You can read the previous post by CLICKING HERE). In today’s 30 Days to ETA post, we’re going to discuss how choosing the right type of business entity at a company’s creation can effect its liability and its ability to sell when it comes time (i.e., ETA Entity Formation). Many people believe that in business exit planning, the idea of preparing a business to sell, occurs just prior to the owner’s desired exit time. This couldn’t be further from the reality of what should happen. Acquisition Entrepreneurs know that in their Entrepreneurship Through Acquisition journey that the time to prepare their future company for sale is at the onset, not as you’re contemplating your exit. Some of the planning we business owners need to do should be done five to ten years before the sale ever occurs, so starting at the beginning with the end in mind should make sense… Enjoy!
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ETA Entity Formation – 4 Types of Business Entities
If you’re starting up a business now or if you’re already in business, choosing the right type of business entity matters a great deal. I’ll provide you with a list of the types of business entities you can create. To know which entity is best for your company, though, you’ll want to consult your own professional team that includes a good attorney, a seasoned financial planner, and a strong CPA.
Here are the four basic types of business entities:
- C Corporations
- S Corporations, a.k.a. Sub-Chapter S Corporations
- Limited Liability Companies, a.k.a. LLCs
There’s actually a fifth type of business, but it’s not an official business entity, so I didn’t include it in my list. If you don’t form your company as a C Corp, an S Corp, a Partnership, or an LLC, then you’re operating a sole proprietorship by default. While it’s a business, it’s not a type of business entity for our purposes here in your Entrepreneurship Through Acquisition roadmap.
With so many ETA Entity Formation options available, identifying the proper formation at the beginning of your Mergers & Acquisitions strategy is the best decision you can make!Sam Palazzolo, Managing Director @ Tip of the Spear Ventures
Which ETA Entity Formation is Right?
Each type of business entity has advantages and disadvantages. Ultimately, business owners choose to operate as an entity for one, or several, of the following reasons:
- Personal Liability Protection – Operating your business under a corporate veil will protect your personal assets should your business run into problems. Additionally, running a company as an entity can reduce personal exposure to risk and act as a hedge of protection over and above what business insurance can provide.
- Transference of Stock or Membership Interest – Within C Corps or S Corps, you can divide stock, move stock or transfer stock among owners or investors with some limitations. You can even give certain types of stock to employees. In an LLC, members (the owners) can re-arrange, divide, re-allocate, or transfer membership interests.
- Flexibility – Vital to entrepreneurs, business entities allow owners to manage their companies as they see fit. They have flexibility over the ownership structure that allows the company to move and flow as individual owners’ circumstances do.
- Tax Reduction Strategies – With the help of a professional CPA, business owners can take advantage of tax-free fringe benefits available to business entities. They can also prevent double taxation issues or plan how much they’ll pay in taxes by operating as an entity and by getting help from an accountant.
Documents Business Entities Should Have
Let’s say you’ve talked to your team of professionals. With everyone’s help, you’ve decided that you’re operating under the right type of business entity. Well, you’re not off the hook yet. No. You’ll need some documents for added personal and business protection. Here’s where a good attorney can help you.
A popular document within partnerships and corporations with multiple owners is a Partnership Agreement or an Operating Agreement. This document addresses how your company will deal with owner disagreements. It specifies who will fill which role and how the company will be managed. Additionally, it outlines how and where the company will handle lawsuits. Written with vast detail or in relatively simple terms, the agreement protects business owners should crisis ensue.
Additionally, many lawyers will recommend that their business owner clients draw-up a Buy-Sell Agreement. Whether you have multiple owners or majority and minority shareholders, you’re all working toward the eventual sale of the company. With this type of document, you can dictate how the company will be sold, for what minimum price it will sell, and under what arrangement it will sell. This agreement can also address what happens to the company in the event of an owner’s death or disability. While not required by law, if you’re building a company to sell it, the very title of the Buy-Sell Agreement seems to recommend its use.
ETA Entity Formation Records
So you’ve settled on an ETA Entity Formation type, now what types of records should you keep? In my experience, the following is the short-list of ETA Entity Formation Records you should keep:
- Selling stock shares
- Issuing stock shares
- Loaning the company money
- Borrowing money from the company
- Placing the company in debt
From legal issues to meeting minutes, you might want to write down anything that happens as it relates to the company’s operations. Consult books, CPA’s, lawyers, and other advisors out there to figure out what types of records your business needs to keep.
The last thing you want as a business owner is to find yourself destitute, trying to win a legal battle without protection and without documentation. Like I’ve mentioned in other posts, I’ve gone through legal battles in business. One of the things I’ve learned is that “he-said-she-said” doesn’t cut it a courtroom. Documents that everyone signed before turmoil arose will be what the attorneys and the judge peruse and use. Hearsay doesn’t win cases; evidence does.
The type of business entity you choose matters. The way you operate the entity and maintain records for the company will also matter. If you are as a part of your ETA in 30 Days journey looking to acquire a business on the road to getting your business ready to sell, you want to make sure that the business entity you ultimately choose is positioned to help you minimize your personal risks and tax liabilities. Not only that, but you want to know which documents you can put in place to make the business’s transition go smoother between you and the buyer or between company owners themselves and the buyer.