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Legal Basics and Business Entity Formation: Crash Course Business Entrepreneurship #5 - YouTube
Channel: CrashCourse
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When will your idea transform from a casual
side-hustle into a full-blown business?
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Is it when your podcast gets sponsorships,
when your catering company is booked for 5
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weekends straight, or when youâve sold your
100th bottle of Slug-be-Gone?
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Basically, when do things get REAL?
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I canât tell you when youâll start to
feel like a businessperson, but the world
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recognizes it when you legally register your
formal business structure.
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You could be an LLC.
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Or a C-Corp.
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Or a B-Corp.
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Or a Co-op.
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So many different letters!
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It can be daunting to move from the abstract
idea stage to the realm of bank accounts,
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taxes, and liability.
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Sometimes, it can feel like youâre making
arbitrary decisions, but weâre going to
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wade through the legalese together.
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Things are about to get legit.
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Iâm Anna Akana and this is Crash Course
Business: Entrepreneurship.
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[Theme Music Plays]
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The legal basics of entrepreneurship arenât
as flashy as generating ideas or staking out
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the competition.
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But think about them like a Choose Your Own
Adventure novel.
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Choosing a business structure opens up a different
future with unique twists and turns.
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So buckle up.
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Legally, you have to register your business.
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And depending on where you live, your government
might have certain requirements to do that.
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In the U.S., you register to say a cordial
âwhatâs up?â to the state and federal
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government.
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They need to know you exist so you can get
the licenses and permits you need to do business
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and -- everyoneâs favorite topic -- pay
your taxes.
[103]
For you as the owner, and anyone youâre
doing business with, registering can create
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some legal and financial protection.
[109]
Specifically, weâre talking about liability
-- or the state of being legally responsible
[114]
for something -- and potentially using helpful
tax structures.
[117]
Weâll talk about a bit of money stuff here,
but check with your governmentâs commerce,
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tax, or treasury departments for more details.
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There are lots of different options to pick
from when you register your business, so itâs
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time to choose a path.
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These are most of the U.S. options, but a
lot of countries have similar structures.
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Letâs jump in.
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A sole proprietorship is a type of business
thatâs owned and run by one person.
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Think freelance writers, independent landscapers,
or even YouTubers.
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This is the easiest Choose Your Own Adventure
decision: choosing nothing.
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If you provide a service or product to someone
by yourself and get paid without registering
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for any kind of business, youâre considered
a sole proprietorship.
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But it has some drawbacks.
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You arenât considered separate from your
business -- youâre personally liable.
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That means your business money isnât separate
from your personal assets like your money,
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car, or house -- and your personal assets
could be taken in a lawsuit.
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Yikes.
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Raising investment money can be tough because
you canât sell stock -- or shares of ownership
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in the company.
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And banks might hesitate to lend money because
they perceive a bigger risk in lending to
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just one person.
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Filing taxes as a sole proprietor is pretty
easy.
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You have whatâs called pass-through status,
where profits are passed straight to business
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owners and are just part of personal taxes,
instead of also being included in the business
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taxes.
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Basically, since the business money isnât
separate from your personal money, you just
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submit once with a few extra forms.
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Also, you have to factor in self-employment
taxes, which are explained on IRS.gov.
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The cool thing about a sole-proprietorship
is that your business expenses can be tax
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write-offs!
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New computer for work?
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Write it off!
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New desk?
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Write it off!
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You want to check with an accountant, of course,
but that is a real advantage of owning your
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own business.
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A partnership is a way for two or more people
to share ownership of a business, which is
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great if you donât want to go it alone,
or for professional groups like attorneys
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or dentists.
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All the fun groups.
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If you choose a partnership, you have to pick
one of three flavors that mostly affect power
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and liability: General, Limited, and Limited
Liability.
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In a General Partnership, you and one or more
partners share personal liability and all
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have an equal say when making decisions.
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Just like a sole proprietorship, itâs the
easiest choice for partners, but personal
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liability can be risky.
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In a Limited Partnership, someone takes on
unlimited liability, so their personal assets
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can be seized in a legal battle, and they
have to pay self-employment taxes.
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But theyâre the head honcho and own and
run most of the business.
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The other partners have limited input, but
also limited liability.
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Theyâre only responsible for a slice of
the business assets so theyâre personally
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protected from lawsuits.
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These are often silent business partners...
who are basically just the money.
[285]
Shhh!
[286]
In a Limited Liability Partnership, or LLP,
everyone gets limited liability.
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Itâs more work to form than a general partnership,
and gives less protection than fancier business
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structures.
[297]
But it does give owners at least SOME liability
protection.
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No matter the flavor, youâll have an easier
time raising money in a partnership than alone,
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since banks might be more willing to lend
to multiple people.
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And you could get investments if youâre
willing to take on silent partners.
[312]
Partnerships are also helpful for tax reasons.
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General partners have pass-through status
for taxes, like a sole proprietorship.
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Everyone splits the profits through the business,
and deals with their own taxes, including
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self-employment taxes.
[325]
Overall, partnerships -- especially LPs and
LLPs -- are more expensive than sole proprietorships
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because they need more legal and accounting
help.
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Now a corporation, sometimes called a C-corp,
is an entity thatâs completely separate
[339]
from its owners.
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Like a person, a corporation can have profits,
taxes, and liability.
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The BBC, eBay, and AirBnB are all corporations.
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Where you incorporate matters for many legal
reasons.
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In the U.S., for example, lots of people form
their legal entity in Delaware.
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If you choose the C-corp path, youâre protected
from lawsuits -- you arenât personally liable
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and have limited liability.
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Funding is also easier, because corporations
can sell stock to the public.
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While corporations can borrow from banks,
they typically find it too restrictive and
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find money other ways.
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Plus, if stockholders -- the people who own
shares of your business -- leave or sell their
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stocks, you can keep chugging along instead
of stopping to restructure.
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But for all these benefits, you have to be
ready to hustle.
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Any type of corporation needs a giant pile
of state and federal paperwork to form.
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They require extensive record-keeping, operational
processes, and annual reports on their activities
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to the government.
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C-corps are also expensive to form.
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And unlike sole proprietors and partnerships,
C-corps pay tax on profits before handing
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money out to stockholders, who also have to
pay their own taxes, which means a little
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less profit for each owner.
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C-corps are also beholden to profit.
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Their decisions have to be based on what makes
the most profit for stockholders.
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A benefit corporation, sometimes known as
a B-corp, focuses on social good.
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Patagonia, Ben & Jerryâs, TOMS, and The
Honest Company follow this path!
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Like any corporation, B-corps give you lots
of protection with limited liability.
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And maybe more importantly, this structure
empowers and protects you to make a difference
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and a profit.
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B-corps are designed to let the CEO -- the
person in charge of the business who may or
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may not be an owner -- make decisions for
social good.
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Even if those decisions are a little less
profitable, the CEO wonât get in trouble
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with stockholders.
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The funding and structure is similar to a
C-corp.
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But you can also look for impact investing
-- people investing money to create a specific
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social or environmental benefit.
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Itâs still really expensive to incorporate,
and B-corps are taxed the same as C-corps.
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Plus, to make sure youâre doing social good,
you have to create even more reports for transparency.
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Get ready for mountains of paperwork!
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A limited liability company, or LLC, is sort
of a corporation-partnership hybrid.
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LLCs can have one or more owners.
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Complexly is an LLC!
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Itâs literally in the name: you have limited
liability.
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Plus, you can still choose to become a corporation
later if you want -- that path is still open.
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Many startups begin with an LLC because of
the protection and flexibility it has.
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In fact, this might help you attract investors.
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LLC stock is privately owned, so being able
to transform into a corporation and eventually
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sell stock to the public might draw in the
financiers.
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And like a partnership, you have pass-through
status for taxes, which can be nice, but you
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still pay self-employment taxes.
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One risk of choosing this path is when an
owner joins or leaves an LLC, you might be
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forced to reform.
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But you can also create a legal agreement
within an LLC to cover ownership transfers.
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A cooperative, or co-op, is a business owned
by the people using it -- like REI or a farming
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co-op.
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An elected board of directors runs the co-op,
while every stockholder-slash-owner can vote
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on the overall direction.
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So stockholders have a real voice!
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The main problem is that the wheels of democracy
turn slowly.
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Stockholders vote on all decisions, which
means that responses to market changes are
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slower.
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But in the spirit of equality, each owner
gets precisely one vote and enjoys limited
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liability.
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You can generate money for a co-op by selling
stocks, and any profits are distributed among
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the stockholders.
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But you might have a hard time getting outside
investment.
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Traditional banks arenât super excited about
lending to businesses where their money wonât
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be guaranteed by one or a few specific owners.
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And, like a corporation, co-ops have the âdouble
taxationâ treatment for stockholders.
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And finally [at long last], a nonprofit corporation
is created to do charity, education, religious,
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literary, or scientific work that isnât
taxed.
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Nonprofits include Amnesty International,
Better Business Bureau, or the Foundation
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to Decrease World Suck.
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If you choose this path, your work benefits
the public.
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So nonprofits have tons of paperwork and record-keeping,
operational processes, and must submit an
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annual report on their activities to the government,
similar to a C-corp.
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Also, owners are well-protected and have limited
liability.
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After jumping through some hoops with the
IRS, the government will grant you tax-exempt
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status, meaning you donât pay state or federal
taxes on any profits.
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And there are strict rules on what to do with
any profits you earn -- like, you can't distribute
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them to stockholders or political campaigns.
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As for funding, nonprofits are often eligible
for grants -- or money given by a government
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or organization for a specific project.
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Other people and corporations can also just
give you money so that they can write it off
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on their taxes.
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And out of the goodness of their hearts, of
course.
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Phew.
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Got all that?
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We made a handy chart for you too, just in
case!
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By choosing our business structure, weâre
also thinking about who we want to work with,
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and what future we see for our business.
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Letâs go to the Thought Bubble.
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You do a lot of tutoring online using free
video chat software.
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But you notice a gap in the market and want
to develop a long-distance tutoring business
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and potentially a new app.
[676]
You decide against a business partner, because
you donât want to share decision-making
[680]
or profits with anyone, and you couldnât
find a co-founder with skills that complement
[685]
yours.
[686]
But you canât handle all this tutoring yourself,
so you plan to hire employees!
[690]
You dig into the legal requirements for how
to pay them, and find some software to help
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you manage payroll, taxes, and more.
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Itâs starting to look like a REAL business,
so itâs time to choose your own adventure.
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You might start out as a sole proprietorship.
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Itâs just you and one employee, and youâre
not sure this is a super long-term endeavor.
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After a couple years, though, you decide to
become an LLC.
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Youâre great at what you do, but some clients
get mean when their grades donât skyrocket
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-- so you need protection from personal liability.
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And then⊠youâre at a crossroads.
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The future looks promising for generating
a tutoring app, but youâre having trouble
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getting investors.
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So you can stick with an LLC or try to transform
into a C-corp.
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Maybe you decide to stay an LLC, but you get
an unlucky dice roll while generating your
[738]
app.
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You spread yourself too thin, and eventually
you canât support all your tutors and developers.
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You eventually decide to cut your losses and
call it quits.
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You had a good run!
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Or maybe you decide to put in a lot of work
and incorporate, and luckily hit the jackpot:
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as your app grows, venture capitalists are
clamoring to invest.
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Youâre quickly becoming the premier tutoring
organization in the U.S. and this business
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might outlive you.
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Thanks Thought Bubble!
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There really is no âbestâ structure because
every business is different, your path might
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change over time, and success involves grit,
determination, AND luck.
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We recommend talking to a trustworthy attorney
or tax accountant for specific and nuanced
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advice, since theyâll know your business
idea inside and out.
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Once weâve chosen a legal structure, we
still have to say âwhatâs up?â to the
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government so they know we exist.
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And this means⊠paperwork.
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Letâs start with the feds.
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In the U.S., you need an Employer Identification
Number from the federal government, which
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will help you with taxes and getting a bank
account.
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If you open a branch of your business in the
Scottish Highlands or the Bolivian Salt Flats,
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youâll need to look at what those countries
require.
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Next, register your business through your
Secretary of Stateâs website.
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There are often small filing fees, and if
thatâs a barrier, try to find an advocate
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at a local Small Business Development Center,
bank, or your stateâs Department of Commerce.
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Someone may know someone who knows a program
to get your fee waived.
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It never hurts to ask!
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The worst they can say is no, go away!
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Then, check in with your local government.
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Are there requirements to doing business in
your city, like a business license you need
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to get?
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And finally, itâs never too early to start
thinking about taxes!
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Review the requirements for your state and
federal tax reporting.
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You could use an accountant or DIY software
like TurboTax -- depending on your needs.
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Make a plan.
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Stick to the plan.
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File your taxes.
[855]
So the bottom line is: registering your business
is a big decision, but an exciting one, because
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you get to define your own path.
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Where do you see your business going in 5
years?
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What does success look like?
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What infrastructure will you need?
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Itâs up to you.
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Next time, weâll talk about how to get feedback
before launching our business, and what to
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do if our idea is falling flat.
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Thanks for watching Crash Course Business
which is sponsored by Google.
[880]
And thank you to Thought Cafe for the graphics.
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If you want to help keep Crash Course free
for everybody, forever, you can join our community
[886]
on Patreon.
[887]
And if you want to learn more about how the
U.S. government regulates the economy, check
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out this video
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