STARTING A BUSINESS
The keys to successfully starting and operating a business are:
- creating a well thought out and realistic Business Plan
- obtaining Tax Advice from an accountant or tax advisor;
- obtaining the appropriate Business Licenses. Almost all businesses require some sort of licenses and some industries require a specialized license with insurance and bonding requirements; and finally
- selecting the form of the Business Entity
There are four basic forms business entities take. They are:
- SOLE PROPRIETORSHIPS
- CORPORATIONS (INCLUDING CLOSE CORPORATIONS)
- LIMITED LIABILITY COMPANIES
Formation and operation of the Corporation and Limited Liability Companies and to some extent Partnerships are governed by the Corporations and Associations Article of the Maryland Code. Each of these business entities are discussed below.
Business owned by one person who has not formed another business entity is a sole proprietor. The risk with a sole proprietorship lies completely on you as the owner. It is usually advisable to select a business form other than Sole Proprietorship for a business entity.
A partnership is similar to the sole proprietorship except that it involves two or more persons in business to make a profit. Each of the partners is taxed with their share of the profits. It is usually advisable to have a partnership agreement between the parties to define their relationship, although a written agreement is not required.
A corporation may be formed by as few as one person. The corporation has the benefit of providing shelter to the owners (otherwise known as shareholders) from liability for the acts of the corporation. A corporation is taxed on its income. The dividends and gains in value of the capital stock of the corporation are taxed to the stockholders. This "double taxing" is the major disadvantage of choosing the corporation as the business form for small businesses. Many corporations (this includes traditional corporations and close corporations) with fewer than 75 stockholders can elect tax treatment under Subchapter S of the Internal Revenue Code. This allows any corporation making such an election to avoid the two tier tax treatment of income followed under the typical corporation. Any corporation wishing to make such an election should seek competent legal and tax advice before making such an election.
The corporate form also has many formalities that can make its operation cumbersome for some businesses. For remedies to these disadvantage see the discussions relating to LIMITED LIABILITY COMPANIES and CLOSE CORPORATIONS below.
A corporation is formed by the filing of the ARTICLES OF INCORPORATION with the Maryland State Department of Assessments and Taxation (SDAT). The ARTICLES OF INCORPORATION include:
- the name of the corporation;
- the purpose for the formation of the corporation;
- additional powers of the corporation;
- the principal office of the corporation;
- the name and address of a resident agent in Maryland;
- the amount of authorized stock the corporation may issue;
- the names of the initial directors (there must be a minimum of three);
- customarily includes provisions whereby the corporation agrees to protect ("indemnify") a director or officer from individual liability
This is not a complete list of the contents of the typical articles of incorporation.
The name of the corporation is legally significant because it identifies who the corporation is. Therefore, it is important to confirm the availability of the desired name for the corporation with the SDAT. It is possible for an LLC (discussed below) to have the same name as a corporation, we recommend that you select a name that has not already been selected by an LLC. The name must also contain the word "company" or "corporation" or "incorporated" or "limited." You may also want to select a "trade name" for the corporation. This name is typically registered with the SDAT.
With all business entities the business may have or develop intellectual property rights. Accordingly, it may be important to register the name or mark of the corporation and to confirm that the business is not infringing on the such rights of other entities.
After the ARTICLES OF INCORPORATION have been filed, the initial directors meet and adopt the BY-LAWS of the Corporation.
The BY-LAWS include:
- when meetings of stockholders and directors shall take place;
- powers of the directors (not in conflict with the Articles of Incorporation);
- the officers of the corporation which are normally a president, vice president, secretary and treasurer and their duties;
- compensation of directors;
- descriptions of the stock certificates and procedures for their issuance;
- the right of inspection of books and records by stockholders;
- the fiscal year of the corporation;
- who may sign checks for the corporation; and
- the procedure for amending the bylaws. This is not an exhaustive list of the contents of the typical BY-LAWS. The BY-LAWS are kept with the corporate records.
The other corporate records include:
- the organizational minutes of the corporation;
- the minutes of the annual meeting of the corporation;
- stock certificates;
- the stock ledger; and
- the corporate seal.
If the corporation has few stockholders, its shareholders may wish to have a Restrictive Stock Transfer Agreement or Buy/Sell Agreement that limits who the stock can be sold to and how the stock is to be redeemed. This agreement also defines what happens to the stock if a stockholder dies or becomes disabled etc. Normally in a small business the shareholders are also employees of the corporation.
In most instances the stockholders and directors will have to have separate annual meetings.
Another alternative to the sole proprietorship and the traditional corporate structure is the CLOSE CORPORATION. Some of the steps of operating a corporation may be avoided by electing to form a "close corporation" under the Corporations and Associations Article of the Maryland Code. In a close corporation the stockholders may elect to not have any directors. In this case the functions of the directors are performed directly by the stockholders. Initially however, at least one director must be named whose term is then terminated at the organizational meeting of directors. A close corporation requires that decision making be by unanimous consent of the stockholders.
If you are forming a close corporation with more than one stockholder, be aware that the failure of the stockholders to agree could cause the corporation to be dissolved because there "is such internal dissension among the stockholders of the corporation that the business and affairs of the corporation can no longer be conducted to the advantage of the stockholders generally". Some of these problems may be reduced by the execution of a "unanimous stockholders' agreement". However, the election to operate as a close corporation must be carefully evaluated.
THE LIMITED LIABILITY COMPANY ("LLC")
The LLC is a common alternative to the corporate structure for the individual. While the legal concept of a LLC began as a partnership of two or more people who obtained limitation from personal liability and favorable tax status, in 1977 the Maryland Legislature created the single person LLC for single owner companies. The single person LLC provides limitation from liability and the single tier tax treatment of income.
To form a limited liability company ARTICLES OF ORGANIZATION must be filed with the SDAT. The Articles of Organization must contain the name of the LLC; the purpose for which the LLC was formed; the address of the principal office in Maryland; the name and address of the resident agent. The name must contain either the words "limited liability company" or "L.L.C.", "LLC", "LC", or L.C.". The owners of the LLC are called "members".
When there are two or more owners an OPERATING AGREEMENT is recommended. The Operating Agreement commonly deals with the capital accounts of each member; the division of profits, losses and distribution (which may be different from the percentage of ownership in the LLC); who is going to manage the LLC, (all of the members or a managing member); the rights of a member to transfer his interest in the LLC voluntarily, involuntarily, and how that interest will be valued; dissolution, liquidation and termination of the LLC; the maintaining of books, records, accounting and tax election for the LLC.
If you are have questions about the process of starting a business or the particular forms of business entities please contact EARL SCHAFFER.