When is the Right Time to Form a Business Entity?

From the moment you have an idea for a new business, it seems that there are a million different things you need to do. Most of those have to do with creating the product or service that you are going to take to market. Without something of value to sell, nothing else matters.

At some point in this journey, you are going to start to think about forming a formal business entity. This is an important step and it certainly isn’t one you can afford to overlook. But when should you register your business? Do you have to form a business entity before you even take the first step toward making your vision a reality? Let’s get to the bottom of these questions and more in the article below.

What Are Business Entities?

Before we get too far into this discussion, let’s make sure we are clear regarding what a business entity is and why it will become necessary at some point along the way. A business entity is simply an organization that you legally establish as a separate structure from your personal life. Once founded, you can do things like sign contracts and own assets through the business as opposed to through yourself personally. This has some notable implications that we will talk about later.

You are certainly familiar with some of the names of business entities, even if you haven’t formed one previously. Two particularly popular options are Limited Liability Companies, or LLCs, and Corporations. After you have decided that the time is right to go ahead and form an entity, you’ll then need to move on to deciding which type of structure is going to be best for your needs moving forward.

Do You Need a Business Entity on Day One?

In many cases, no – you don’t have to form a business entity right from the start. Often, it will be perfectly acceptable to get started working on the business and proving the concept before you go any further. By default, if you are operating any type of business and you haven’t registered it officially, you are considered to be a sole proprietor. So, if you start to make a little money and aren’t operating as a formal business entity, that money is taxed as a sole proprietorship (meaning it will be treated as personal income, rather than as the income of a separate business).

An exception to the idea of starting a new business without a formal entity in place is if you are starting something that is going to hire employees and take on other responsibilities from day one. Consider the idea of opening a restaurant. This isn’t something you can just “explore” for a while and see if it works – you pretty much have to go all in on hiring people, leasing a space, acquiring equipment, etc. In that case, you’ll need to have your business entity registered right away so you can behave like an official business and do everything that is necessary to get up and running.

A Few Factors to Weigh

To understand when the time is going to be right to form your business entity, it’s important to understand what factors play into this discussion. Some of the relevant considerations are as follows –

• Liability concerns. Much of the fuss of forming a business entity comes down to protecting your own interests and shielding yourself from liability. With that in mind, you’ll want to think carefully about the liabilities you might be exposed to while running the business in its early days. At some point, those liabilities are going to become more than you are willing to risk, and you’ll want to formally register the business.
• Tax matters. The other big issue with business formation, in addition to liability, is taxes. There are certain situations where one formation strategy will be better than another from a tax perspective. As mentioned earlier, at the start you will just be paying taxes through your personal filing, but that can change when you run an LLC or a corporation. It’s hard to know on your own how all of this will play out, so teaming up with a tax professional to make these key decisions is smart.
• Seeking funding. If you want to get funding for your business you will almost certainly need to formally register it as an LLC, corporation, etc. Without that, you’ll struggle to get the funding you need, as investors might be wary of working with a company that isn’t even set up as a proper entity at this point.

Those aren’t all of the factors that you will want to think about, but they certainly are a starting point. You can always contact a law firm like Fisher Stone which specializes in this kind of work to discuss your situation and work out a timeline that makes sense.

Signs That You Can’t Wait Any Longer

For this section, let’s assume that you have been operating your business for a while and things are starting to pick up steam. You have a few customers, at least, and you are seeing nice potential for what this operation could become in the future. If you are seeing some – or all – of the signs below present in your business, the time is probably right to form your business entity. And, if that’s the case, be sure to contact Fisher Stone today to discuss our services and how we can get this started right away.

• You are hiring employees. We talked about this briefly earlier on the page, but hiring employees is likely a sign that you should have a proper business entity in place. Not only does having employees mean being opened up to potential liabilities, but it also means you’ll need to manage payroll taxes, comply with labor laws, and more. This is one of the key steps along the journey of a business that leads to finally making things official.
• You have consistent revenues. A steady stream of income – even if you aren’t particularly profitable just yet – is a good sign that you should form a business entity. With revenues rolling in, you are past the “proof of concept” stage and are now working on building something that will hopefully last.
• You need to sign contracts. If you need to sign contracts with other organizations to keep growing your business, it might be difficult – or impossible – to do so without having a business entity in place. Other parties might only be willing to sign deals with formal businesses, so your personal signature may not be enough to get the job done. Again, when you start to run into this kind of problem, take it as a sign that you can’t wait any longer.

Most likely, it will become pretty obvious that you need to form your business entity as soon as possible. You’ll keep noticing issues that come up because you don’t have an entity formed, and you will start to feel uncomfortable about the degree of liability you are accepting. When the signs are right in front of you, take the step and make sure you don’t regret waiting too long.

Picking the Right Type of Entity

The matter of picking the right type of business entity is a topic that is deserving of its own post – or book – so we aren’t going to be able to cover it all here. However, before wrapping up this page, it’s worth taking a moment to discuss the basics of which type of entity you might want to consider based on your plans.

For many businesses, a Limited Liability Company, or LLC, is going to be the right choice. While it is often thought of as a type of entity that is suitable for small businesses – and it is certainly that – having an LLC doesn’t limit your growth moving forward. You can still grow to become a rather large business, and you may morph into a different type of entity later on. The big advantage of going the LLC route is the low cost of getting started and the minimal regulatory requirements. LLCs are simple to start, cheap to maintain, and provide owners with a degree of liability protection.

Companies that want to secure funding from outside investors or banks may prefer to go the corporation route as opposed to an LLC. With a corporation, you’ll be able to offer shares in your business in exchange for funding, and while LLCs can have investors, the structure isn’t as friendly for such a setup. This is definitely not a decision you want to make on your own without some professional guidance, so invest in help to make the right choice.

Let Us Handle the Details

It would be a shame for a great business idea to be bogged down by red tape. Forming a business entity at the right time, and forming the right type of entity, is an important step in the growth of this new company. When you should register your business? Instead of sitting around and stressing over this topic, just reach out to Fisher Stone today for direct advice from an experienced firm. We’ll help you understand the various factors that impact this decision so you can confidently move forward and see your business reach its full potential.