The Old Joel on Software Forum: Part 4 (of 5)

LLC vs. Sole Proprietorship

I am just about ready to venture into an on-line business. On this website, customers will be able to purchase adult romance enhancement products. I.e., lotions, massagers, even sex toys, etc. Due to the fact that this will be on-line, thus, exposed nationally/internationally, I'm not sure if the LLC is a better choice for me. I would like to believe that the liability is minimal in this type of business, but the tax advantages of the LLC might be beneficial, because of the exposure level. Or should I be looking into and S-Corp? Anyone have any thoughts on this?

TCC
Thursday, May 6, 2004

http://www.redtechpress.com/incorporate_your_business.htm
http://www.activefilings.com/en/information/faq_structures.htm

Code Monkey
Thursday, May 6, 2004

An LLC can protect your business partners from some liability but will not protect you from liability.

What state are you in that it is a tax advantage? Usually it is same as sole, minus the fees and taxes your state imposes.

Dave Winchester
Thursday, May 6, 2004

CM had two really good links there. The short answer is "read the links" but the longer one is about liability.

If you are the sole "person" in a company, in the US, incorporation will not shield you. Doctor's incorporate so they other doctor's don't lose their shirts when you leave a 10" pair of scissors in someone. You can still be held personally responsible. (Yes, this is a good thing)

If liability is your only concern, then I cannot see it really matters. Go for cheap with Sole Proprietorship. Then go and buy liability insurance (you have to buy it whether you are a corporation or not). Assuming you have not had any prior claims it will run around $1500/million in coverage.

Some people I know, do not buy any. They figure they have nothing to lose and the cost/benefit (insurance expense of $7,000 to start) isn't worth it.

MSHack
Thursday, May 6, 2004

I recently formed an LLC for an online venture. The liability protection afforded sole members without employees may not be 100% but I don't believe it's non-existent if proper steps are taken to separate business and personal affairs. In my state, Ohio, the filing fee is $125 so it's fairly cheap insurance regardless. I understand that in California, for example, it's much more expensive.

Unless you're going to do business under your own name, you'll probably have to make a "doing business as" name filing so the actual savings would be the difference between that and LLC/corp filing fees.

Some business structure also lends a little additional credibility for a startup. LLCs generally have less formal formation and operating requirements than corporations.

If you're going to have employees then you should definitely do an LLC or corporation.

There are no tax advantages to an LLC per se. It can be taxed flow through like a sole proprietorship or like a corporation. Default is flow through, corporate taxation is an election.

Doug
Thursday, May 6, 2004

My limited understanding (I researched this years ago) is that a C-Corp will insulate YOU from your COMPANY.

IMHO, it's better to spend the money ($100 or so) and effort (12 hours a year of effort/ paperwork) than spending it on Liability insurance.

But, you can get quotes and compare.

Father of a friend of mine had no home owner's insurance and my friend had built a rock climbing TOWER in thier front yard. I asked if he was worried about a lawsuit. He said "they wont' sue if you don't have insurance (deep pockets)".

Likewise, unless you have a lot of assets in your company's name (and there's no need to with this sort of business) there's nothing for a litigous customer to GET if they sue you. (If you're incorporated).

Bottom line: talk to a lawyer AFTER your read some good "Inc. Yourself" style books.

Also, there are some other C-corp benefits like deducting your healthcare insurance premiums.

Mr. Analogy
Thursday, May 6, 2004

I read lots of conflicting information regarding LLCs. Granted they function slightly differently based on what state you get it from, I would think they would be more consistent.

The biggest disagreement is when it comes to whether an LLC protects you from liability or not. It is obviously better than a sole proprietorship where you are the company whether you are using a ficticious name or not.

As far as I know, an LLC *will* protect you from liability as much as a corporation as long as you follow the guidelines to the letter. If you make any mistakes, or do not do what you are supposed to do (keep books correctly, seperate business expenses from personal ones etc...) neither an LLC nor a corporation will protect you. Lawyers will find a way to pierce the shield.

So long as you play by the rules, you are going to be protected although there is no guarantee either with a corporation or an LLC.

Well, that's what I know. Does anyone know any good books explaining this? I guess I could always spend my life savings to see a lawyer for an hour and have her explain it to me.

grunt
Thursday, May 6, 2004

Actually, any type of business incorporation -- LLC, S Corp or C Corp -- should provide limited liability. I think some of the confusion stems from the fact that in some states, an LLC can be owned/run by a single person, while other states require two or more people.

"Limited liability" means exactly that -- it separates your personal assets from your business assets. If your business gets sued, you could theoretically lose all of the assets in your business, but the creditors won't be able to reach your personal assets like your house. Think of it like a firewall between your business assets and your personal assets.

The downside of this is that you have to respect that these assets are completely separate. I.e., you need to have separate accounting and bank accounts for your business assets, and you can't just dip into the corporate till whenever you need some extra spending money. If you blur the line too much between these assets, a court could essentially nullify the limited liability. (This is called "piercing the corporate veil.")

You also have to respect the necessary corporate formalities, like having corporate officers and holding meetings. Generally, corporations need to be treated more formally, while LLCs can be fairly informal.

Each state has subtle differences in its corporations laws, so you should definitely check with a lawyer before incorporating. (You could also incorporate in another state, like Delaware, but that's more complicated.) And do some research beforehand -- there are plenty of good books on the subject, including from Nolo Press.

Robert Jacobson
Thursday, May 6, 2004

Aren't there also some complications when you start selling products outside of where you incorporated? I could be way off...

grunt
Thursday, May 6, 2004

Sorry Grunt, I think we crossposted.

Just to clarify, the name "LLC" is an acronym for "limited liability company," so it should provide limited liability in any state -- assuming that you meet the legal requirements for owning/managing an LLC. Some people assume that limited liability is a magic bullet that negates the need for liability insurance. It isn't -- all it does is separate your business assets from your personal assets.

As for books, search Amazon.com for "Nolo corporation" or "Nolo LLC." There are a lot of books that look promising.

Robert Jacobson
Thursday, May 6, 2004

I think this is the point where we can all say, it depends and you should contact a local attorney. :) $500 spent now is much better than the $500/hour spent later.

MSHack
Thursday, May 6, 2004

The only major complications about incorporating elsewhere are that you also have to register to do business within your state (which is usually a very simple form with your Secretary of State), and that you might have tricky issues around taxation.

The big Fortune 500 corporations usually incorporate in Delaware (which is perceived as being slightly more favorable for corporations) but have their corporate headquarters elsewhere. For small businesses, the general rule of thumb is that it's usually simpler/cheaper just to incorporate in your own state. OTOH, some small corporations (including Fog Creek) prefer to incorporate in Delaware. Try an "Ask Joel" to get his thoughts on the issue. <g>

Robert Jacobson
Thursday, May 6, 2004

Agree 100%, MSHack. Most attorneys will very happy if you do some research in advance, though. (Always better to have a client who's more knowledgeable about his options.)

Robert Jacobson
Thursday, May 6, 2004

TCC, I would not just assume that exposure to liability is limited in the type of business you are contemplating. In some states in the U.S., selling the kind of products you describe is actually illegal. No, I'm not kidding.

http://www.austinchronicle.com/issues/dispatch/2000-08-11/xtra_feature2.html
http://cnews.canoe.ca/CNEWS/WeirdNews/2003/05/01/77161-ap.html
http://www.cnn.com/2004/LAW/02/11/obscenity.trial.reut/

Who knows if these laws are really enforceable, how they affect online merchants, and so on. But it probably wouldn't hurt to spend an hour with a lawyer to see what the best option is for your "entity type". Setting up an LLC in most states will probably cost you a couple of hundred dollars, maybe up to a thousand if you actually have the lawyers do all the work, and the taxation in most states won't be any different than it would if you were a sole proprietor.

John C.
Thursday, May 6, 2004

I hope you'll publish details of the lawsuits you get on this forum.

"My client used the company's dildo your worship and anointed it with their lotion first, but instead of feeling romantically enhnanced like the heroines in a Barbara Cartland novel, she felt like a cheap whore in a honky-tonk that had been closed for lack of planning permission."

Stephen Jones
Friday, May 7, 2004