Starting your business venture: Some basic considerations

You have that itch. You have that great idea. You are tired of academics. You want to start making money.  Whatever your motivation, you want to harness your entrepreneurial spirit into creating a new business. So where do you start and what do you have to think about besides the money-making idea that you are ready to introduce to the world?

This article offers some basic pieces of advice for your immediate consideration so you can do things legally, the right way, the way that won’t lead to problems down the line. It goes without saying—but must be said—that talking to a good lawyer and talking to a good accountant are two of the first steps you should pursue.  You also need to ask yourself certain questions and be sure of the answers!

For instance, do you strike out on your own and just ‘do your thing’ or do you form a company? And if you form a company, what kind of company and who else, IF anyone else, should be part of your enterprise? And where do you get guidance about forming the company?

Well, you can hang out your business shingle and use a fancy name that you have thought up.   If you do this, then the business will be considered simply you, an individual, doing business. This is where the term “DBA” or “doing business as” comes from.  You don’t form a separate company but just conduct business under your name or under a name you have given to your business.

With such an endeavor, all of the risks and business liabilities are personal to you.  All of the business income is yours to keep but taxable to you personally.  All of the business expenses are also yours to keep and you can deduct them as allowed by law from your personal income tax forms.

Getting Started: Three Things You Must Consider if You Simply Hang Out Your Shingle

First, the law requires that if you do business under an assumed name, you must comply with Illinois’ Assumed Business Name Act (805 ILCS 405) which provides that you have to publicly disclose the name under which you are conducting or transacting business if it is not your real (given) name.  You do this by filing the required assumed name certificate with the clerk of the county in which you intend to conduct or transact business, and you also must publish notice of this certificate filing in the newspaper for three consecutive weeks.  Take a look at the legal notices in your local newspaper and you will see the variation in types of such notices.  This requirement is to make sure that you go on ‘public record’ letting the world know that you are going to conduct business under a name that is not your actual name. 

Second, before publishing your notice, you need to make sure that the name you want to use is not being used by another business. For if it is, you may have exposed yourself to liability under the state and federal trademark and trade name laws, including deceptive business practice laws.  This same concern will hold true even if you conduct your business as a corporation or limited liability company, which are discussed below.  You can’t engage in a business using words, or colors, or symbols that might cause the public to believe that your business is actually someone else’s business. 

Third, if you elect to conduct your business in this manner, meaning personally, then you have put at risk all of your personal assets (money, cars, and houses to name a few) that a creditor of your business might be able to access in order to satisfy a business debt you owe.  On this last point, it’s a little more complicated than just noted, but the point is that without forming a company, you have not insulated yourself from personal liability if things go wrong.

What Are Your Alternatives to Conducting Your Own Business? How About Corporations and LLCs?

Anyone who has listened to a LegalZoom commercial knows the magic words:  corporations and limited liability companies. (By mentioning that company, I am neither encouraging you nor discouraging you from using its services.)  What we are talking about here is having you form a company in order to be able to conduct your business under the legal umbrella of that company.  In each case, the company will in effect own the business and you will own, manage, and/or be employed by the company.  And by conducting the business under a company umbrella, and assuming you do things correctly, you have insulated yourself from personal liability so long as you comply with the legal formalities required of the business type you adopt.  Any liability of your company will be limited to the assets of the company. Let’s now review some options for the type of business entity you might create.

A. WHAT IS A CORPORATION? WHAT ARE ITS BASIC PURPOSES AND FUNCTIONS?   A corporation is a legal entity that is created by following the dictates of the Illinois corporation statutes. It is legally distinct from the stockholders who own the corporation.  There are three basic business corporation types:

1. The basic corporation, sometimes referred to as a “C-Corp” for short, with “C” being a reference to the subchapter of the IRS Code that     applies to corporate taxation.  A “C” corporation is a separate taxable entity. It pays corporate income taxes on its earning just like a private individual pays personal income taxes on the person’s earnings. If it then distributes its income to its stockholders (think ‘dividend’), the stockholders (think you) pay income taxes on that distribution.  Or if the corporation pays part of its income in the form of salaries to its officers or employees, then the officers and employees (which    could be you) pay tax on the income they receive.  This is called “double taxation”.  The income is taxed first at the corporate level and then again when the stockholder or officer or employee receives part of the income in the form of salary or dividend.
2. The second type of corporation is what is commonly referred to as an “S-Corp”.  This entity is simply a basic corporation whose stockholders have filed the requisite paperwork with the IRS and have elected to have the corporate income and expenses taxed in a different manner under subchapter S of the IRS Code which simply means that the corporation will be taxed as if it was a partnership, with income and expenses passing directly through to the stockholders in proportion to their investment, thereby avoiding some double taxation.  The income is not taxed at the corporate level so double taxation is avoided.
3. The third type of corporation is what is called a “Close Corporation”.  It is basically a C-Corp with two major differences.  First, as discussed more below, the stockholders of a Close Corporation are allowed to manage the corporation directly, rather than having a board of directors manage the corporation.  Secondly, restrictions can be placed on the shares of stock representing the ownership interest in the corporation so the stock is not freely transferrable.  Hence the reason for the name “Close” corporation.  It allows the corporation to be closely managed by its owners and assures that any one stockholder cannot simply transfer his or her shares to someone outside of the corporation without the corporation and its stockholders having some preemptive rights over that stock transfer.  Think of you and your two friends forming the business.  None of you wants one of your other friends to sell the stock to a third party whom you have no interest in having as a co-owner of the business. The permitted restrictions help you manage that concern.  Of possible interest, a Close Corporation can elect to be an S-Corp for tax purposes.

B. WHAT GENERAL RULES APPLY TO RUNNING A CORPORATION, WHO ARE ITS MEMBERS, HOW ARE ITS FINANCES MANAGED AND WHAT PROCEDURES GOVERN MEETINGS?

1. Since a corporation is a creature of statute, in this case Illinois’ Business Corporation Act of 1983 (805 ILCS 5/1.01et seq.), you have to follow the requirements of that Act to form and manage the corporation.  In addition, should things “go south” in your business, you have to follow the requirement of that Act in dissolving and terminating your business.
2. One of the key attributes of a corporation is that the persons who have ownership in the corporation—the stockholders (sometimes also called the shareholders) — do not have to be the same persons who manage and operate the corporation.   Also, the persons who form the corporation, and who are called the incorporators, don’t even have to be the stockholders or managers. Your lawyer or accountant could sign the incorporation paperwork.  An individual who acts as an incorporator must be at least 18 years of age.
3. Once the entity is formed, you will promptly hold a meeting of the stockholders who bought the initial stock of the company.  The money paid for the stock represents the initial capital that the company has to work with.  It’s possible that a person has given the company hard assets or real estate in exchange for stock.  Those hard assets or real estate likewise become the capital of the company.  At that initial stockholders meeting, the stockholders will elect a board of directors.  There must be at least one director.  So, if three of you get together and invest in this new company, you can choose to have only one or two of you become directors to oversee the management of the company.
4. After they are elected, the directors promptly convene a meeting and, among other things, elect the officers of the company.  The Illinois Business Corporation Act provides that there must be a President and a Secretary.  Often there is also a Treasurer or even a Vice-President.  Any one officer can also hold a second office except that it is a good practice to have the President and Secretary be separate persons.  The other good news is that the same person can be a stockholder, a director, and an officer.  That is usually the case with small new companies.
5. Corporations also are required to adopt what is known as the corporate by-laws.   This is essentially the set of internal rules which govern the manner and procedures by which the corporation will manage and operate itself.  These rules are in addition to the requirements mandated by the Illinois corporation statutes.
6. Since corporations are, as noted, creatures of the Illinois statutes, they have no human existence, only a paper existence. So the Illinois Act requires that your company designate a live person to be the registered agent of the company and that your company designate an office location in Illinois that is deemed to be the registered office of your company.  This designation should occur when you file your initial paperwork with the Illinois Secretary of State to incorporate your company.  The purpose of having this live registered agent with an actual registered office is to make sure that there is a person and location to whom all legal paperwork, correspondence from the Secretary of State, and other official government notifications, usually tax forms and notice of lawsuits, can be sent.
7. It is the registered agent’s job to accept that paperwork, and once it is accepted, your company is deemed to have been served the legal paperwork or notice.  Oftentimes the corporate President serves as the company’s registered agent but at times, the company’s lawyer acts as the registered agent.  Once a year you have to renew your corporate existence with the Illinois Secretary of State.  That office will send to your registered agent at his/her registered address the annual paperwork for renewing your company’s existence.  If you have the bad fortune of being sued, the lawsuit paperwork also will be served on your registered agent.
8. The good news about these stockholder and director meetings is that you don’t have to physically meet.  If done correctly, the meeting can be virtual or by phone conference with everyone waiving the statutorily required notice.  Just as if you met in person, minutes will be drawn up and signed by the stockholders and directors.  The requirements for corporate meetings are also spelled out in the Illinois Act.

B. THE ‘LIMITED LIABILITY COMPANY’ or ‘LLC’: An alternative to the corporation. This type of business entity is also authorized by statute, in  this case Illinois’ Limited Liability Company Act (805 ILCS 180/1-1 et seq.),  known by its common acronym “LLC”. LLCs don’t have stockholders, but rather have members. The members are the owners of the LLC. Rather than being issued a stock certificate, members are issued a membership interest certificate to evidence their ownership of the LLC.

1. Managing the LLC is less formal than in a corporation, as there is no requirement for a board of directors, meetings, minute keeping, quorums and other formal requirements that are imposed on corporations. The LLC members can manage the LLC themselves, just like a group of partners.  Or the members can appoint one or more managers to manage the LLC.  The managers do not necessarily have to be LLC members, but often they are.  Please note that while there is no age requirement for being a member, you have to be at least 18 years of age to be an ‘organizer’ of an Illinois LLC, meaning the person who fills out, signs, and files the initial paperwork that sets up the LLC.   
2. The affairs of an LLC are usually governed by what is known as an operating agreement which, in some respects, is similar to corporate by-laws. This document is essentially the set of rules governing the manner in which the LLC will manage and operate itself.  These rules are in addition to the requirements mandated by the Illinois limited liability company statute.  While it is not mandatory to have an operating agreement, it is highly advisable to have one.
3. Also, as an LLC, like a corporation, is a creature of statute, the LLC must have a registered agent and a registered office, just like is required of a corporation.  The LLC registered agent and registered office have the same responsibilities and purposes as the corporate registered agent and registered office.  In addition, like corporations, an LLC has to renew its existence annually with the Illinois Secretary of State.
4. Another advantage of an LLC is how the company’s financial interests are handled. A corporation distributes its income (think dividends) to the stockholders (the company owners) on a ‘per share’ basis.  An LLC, on the other hand, can distribute its income to each member equally, or based on their capital contributions, or in other ways.
5. Taxation rules are also different for LLCs.  The general rule is that the LLC is considered a pass-through entity.  The income and expenses pass through the LLC to the members and the members are taxed as if the company was a partnership or, if a single member, a sole proprietorship.  There is no taxation at the LLC or company level before the income is passed through to the members.  An LLC can, however, file paperwork with the IRS and elect to be taxed as a business corporation and, if it meets the requirements, as an S corporation.

Final Considerations—Especially Choosing a Name!

A key decision you will make in forming your company, whether a corporation or LLC, is what name you should give it. As noted above, you must check with the Illinois Secretary of State to assure yourself that the name is available.  If it is, you can even file paperwork and pay a small fee to reserve the name for a short period of time.  This action lets you reserve the name and then make the decisions and fill out and file the paperwork to formally form your business.  Again, as noted, you want to make sure that the name you plan to adopt does not create a trademark or service mark violation, or trigger an issue of deceptive practices. 

A corporation will be required to have as part of its name one of the following words:  Corporation, Corp. Limited, Ltd., Incorporated, or Inc.  An LLC will be required to have as part of its name one of the following words:  Limited Liability Company, LLC, or L.L.C. 

Also, like individuals, corporations and LLCs can adopt assumed names and conduct business under an assumed name, provided they file the necessary paperwork for that purpose with the Illinois Secretary of State. For example, “Outback Steak House” is the assumed name under which Bloomin’ Brands, Inc. operates.
There are a lot of other intricacies to forming and operating a corporation or an LLC that are beyond the scope of this short newsletter article. The purpose of this article is to give you basic considerations to think about that will guide you in taking your initial steps to start a business.

As noted at the start of this guide, no matter what form of business you hope to undertake, it is important that you get not only legal advice, but that you talk to a good tax accountant, before starting up the business.   You may want to also talk to a good insurance agent who can assist you with the type of insurance your business may require.

So, harness your entrepreneurial spirit—do your homework—and may good luck follow you.