It’s the end of the year. You have been working on your business plan all year. You are finally ready to pull the trigger because you are going to have some extra time to work over the holidays. You have been paying attention here long enough that you know you should form an entity before you get started.
Before you form that entity, take some time to consider this:
Forming an entity at the end of a calendar year can subject you to some fees that you could otherwise avoid by waiting until the beginning of the year to form. You need to consider the cost before you simply form your business. Consider:
Will You Begin Operating Before the New Year?
Will you offer your products or services before the end of the year? I mean, really. Are you going to take a new consulting client on Christmas Eve? Are you going to have a lot of time to spend on Customer Service between helpings of leftovers and trying to put together another kid’s toy with instructions written in Chinese (or whatever Google Translator happened to spit out from the original language of the instructions). Will you actually begin operating your business? If not, you may want to postpone the formation because there is no benefit, but the extra fees could likely double your formation cost.
Will You Sign Any Contracts Before the New Year?
One of the biggest issues in the timing of entity formation is the issue of Promoter Liability. Promoters are personally liable for any obligations incurred prior to the formation of a legal entity.
Promoter is a person working to get a business started before the formation of a legal entity.
That means, if you need to (1) sign a contract (2) finance some purchase or (3) hire someone to perform work you may be creating liability for yourself that could create problems for you down the road. If you will be incurring liabilities, you should consider the cost of starting now. Is it lower than the personal liabilities you may face if you do not limit your liability and protect yourself from those obligations? If so, you may want to consider forming your entity immediately to make sure you are protected.
Can You Negotiate an Assignment of Your Contracts
With everything I just mentioned in mind, is it possible for you to negotiate the ability to assign any contracts or obligations to your entity when it is formed? As much as promoters are liable for obligations they entered into before the formation of the entity, assignment of that obligation to the LLC (and indemnification by the LLC), would protect you from that personal liability. Then, you are only looking at a couple of weeks of potential liability with an assignment on the formation of the entity. This is easy enough to have in your agreements (and most vendors do not have an issue as they do not completely understand the distinction). This is something that would limit any long term liabilities you may face and could save you some precious money in your first few months.
Do the Contracts You Need to Sign Require a Personal Guarantee?
This primarily applies to borrowing and leasing. Those types of contracts typically require you to sign a personal guarantee with any agreement you enter anyway. If that is the case, you can make sure the agreement can be assigned to the entity when it is formed, but you can go ahead and sign it because you have personal liability for that agreement anyway. You still want to negotiate assignment provisions in the contract, but you will not see any benefit to waiting for the LLC to get started.
****THIS ADVICE IS ONLY EFFECTIVE HERE IN THE LAST FEW WEEKS OF THE YEAR.****
Understand, I am not advocating putting off the formation of your entity for any reason other than the practical effect a couple of weeks can have on your business. The costs you may incur as a result of forming early could be:
Business Privilege Tax
In Alabama, every new entity formed is required to pay an initial Business Privilege Tax within 2.5 months for forming. This tax is also assessed every year in April. The initial Business Privilege tax is designed to ensure the state of Alabama receives its money in the initial year of a business existing. It is not prorated. That means, you must pay $100 for the year you file whenever you file. If you file right at the end of the year, you will be required to pay the initial return within 2.5 months of filing and the annual return in April of the following year. This tax is imposed on formation, not operation. That means, if you form your company in December and do not begin operating until January, you spent $100 you didn’t need to spend.
This is a tricky one. The business license for most jurisdictions is an annual license. Business license renewals do not always happen during the calendar year. So, it is a good idea to know when the applicable business licenses renew for your planned venture. It is also good to know if you will incur extra fees, like with the privilege tax, by forming early. If the year is not the same as the calendar year, this may not matter at all at the end of the year, but it is certainly worth considering.
The practical side of what I am suggesting is that you think through your launch on multiple levels. Remember, as a business owner, you need to make decisions about more than simply the effectiveness of the launch date.
I will talk to you next week, unless you talk to me first 😉