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Business Entity Formation 101

On Behalf of | Jan 5, 2018 | Firm News

Written By:  Kristy Garrett

A reoccurring question that commonly arises in the area of commercial transactions is, “What type of legal entity should I form for my business?”  The answer to that question depends on, among other factors, the type, the size, the management, and the intended purpose of the business.  There are many important considerations when deciding which type of entity will suit a client’s business objectives.  It is most advantageous for these considerations to be made prior to any business action or operations being taken.  This article will discuss the questions that should be answered prior to picking an entity type for a business operation and a brief description of three (3) of the most popular entities utilized.  The information below is to provide a general framework only and a complete legal and tax consultation is recommended prior to taking any formal steps in the corporate formation process to ensure that the entity is properly formed and structured and in order to realize the intended advantages.

Considerations For Choosing An Entity Type

  • Management: Will this business be run by a single manager?  Will there be a board of directors?  Will it need to have officers?  Will it be run by its sole member or members?  Will decisions be made by a majority vote of the owners?  Will certain decisions require unanimous consent?
  • Size: Will this company be a closely held company?  Will there be just one or two owners?  Does the structure need to accommodate several owners?
  • Tax Considerations: There are important tax reasons and implications for choosing an entity structure for a particular type of business.  A consultation and analysis by an accountant is an important step in the business formation process.
  • Future Growth and Changes: Are there plans for growth and expansion or is the company’s purpose limited and distinct?
  • Capitalization: How will the company be capitalized?  Is there a need for investors now or potentially in the future?  Will the company need to obtain financing?

 Common Entity Types

  • Limited Liability Company or “LLC”:  The LLC is a business structure that generally combines the pass-through taxation of a partnership or sole proprietorship, with the limited liability of a corporation.  An LLC is not a corporation in itself; it is a legal form of a company that provides limited liability to its owners, when properly structured and capitalized, and under certain circumstances.  It is often more flexible than a corporation, and it is well-suited for companies with a single owner or a closely held organization.  LLCs have less corporate formalities than corporations.  Additionally, ownership in an LLC is represented by a “membership interest” or an “LLC interest”.   An LLC can be managed by a manager or managed by its members.  A member managed LLC is most common.  An LLC is formed in Alaska, among other requirements, by the filing of Articles of Organization with the Division of Corporations and the management of the entity is structured by its Operating Agreement.
  • C-Corporation: A C corporation, similar to an LLC, generally limits the owners’ personal liability for business debts and court judgments against the business.  A C corporation is an independent legal and tax entity, separate from the people who own, control, and manage it.  Additionally, ownership in a corporation is represented by shares of stock that can be issued to several owners, called shareholders.  Corporations in Alaska must have a President, Secretary, and Treasurer.  Corporations are better suited for operations with several owners and a structure that supports having officers, a board of directors, and regular board and shareholder meetings.  A C corporation is formed in Alaska, among other requirements, by the filing of Articles of Incorporation with the Division of Corporations and the management of the entity is structured by its Bylaws.
  • S-Corporation: An S corporation is a regular corporation that has elected “S corporation” tax status, which means that the corporation is not a separate taxable entity like a C corporation.  Basically, owners pay income taxes as if they were sole proprietors or partners. S corporations are very similar to LLCs, but there are a few key differences and certain restrictions on S corporations.  S corporations have several limitations that LLCs do not and include the following:  (a)  Each S corporation shareholder must be a U.S. citizen or resident; (b) S corporations may not have more than 100 shareholders; and (c) S corporation profits and losses may be allocated only in proportion to each shareholder’s interest in the business.  Like regular C corporations, S corporation owners have to issue stock, hold regular board of directors’ and shareholders’ meetings, and keep corporate minutes of all meetings.