With its central location, relatively low cost of living, and abundance of great resources, the Des Moines Metro is an excellent home for small businesses and start-ups. Whether you are starting a food truck, a small clothing business, or the next big tech company, the legal steps you need to take to get your business up and running are largely the same. Prior to starting a business, it is important to consider creating a legal business entity. This article covers why creating a business entity is important and the basics you need to know to create your own business entity.
Why a legal entity?
Creating a legal entity for your business is important because it can protect you and your personal assets from liabilities incurred by your newly formed business. These liabilities can range from debt obligations to legal liability for the negligent actions of you or your employees acting on behalf of your business. Additionally, creating a business entity gives structure and guidelines for the operation of your business, both through an operating agreement/by-laws as well as the Iowa Code (LLCs are governed by Chapter 489, and Corporations are governed by Chapter 490). This includes rules on membership/director rights, voting powers, and business decision making.
Limited Liability Company
The Limited Liability Company or LLC is the most popular business designation used by businesses. This is due to the relative simplicity of the entity, as they are governed fairly informally, have flexibility in how to split financial interests and distributions, and are easier to set up compared to Corporations. This option is perfect for small and local businesses who do not wish to follow a corporate structure but wish simply to have liability protection and some guidelines for how they do business.
In order to create an LLC, you first need to file a Certificate of Organization with the Secretary of State. This Certificate of Organization is governed by Iowa Code Chapter 489, Section 201. In short, you will need to include:
- The name of the limited liability company;
- The street address of the initial registered office;
- The name of the registered agent for service of process;
- Designation as to whether the LLC is Member-managed or Manager-managed; and
- Duration (can be open-ended).
This document needs to be submitted online, through the Iowa Secretary of State’s website, or in-person at the Iowa Secretary of State’s office, and a filing fee of $50 needs to be paid. Approval of your LLC filing takes up to 3-4 weeks.
In short, the Operating Agreement is the set of rules or governance to which your business operates. Although not required by law, you will next want an Operating Agreement and have it approved by the members of your LLC. If you should decide not to create your own Operating Agreement, Iowa Code 489 provides standardized governance for LLC operation. Additionally, should your Operating Agreement not cover a certain topic, Iowa Code 489 will supplement. The Operating Agreement typically covers the following main issues:
- Operation and management systems for the LLC;
- The manner in which profits and losses are divided/shared;
- Procedures for addition or departure of members of the LLC;
- The value or valuation technique to use for the LLC;
- Ownership interests for LLC members, including voting rights and profit-sharing.
Drafting an Operating Agreement is a difficult task and one very hard to get right. Though it is possible to draft your own, it is highly recommended to seek legal help to draft them.
Owners of an LLC can choose to have members (the owners) or designated managers manage the LLC. For a member-managed LLC, members participate together in the decision making processes of the LLC. Each member is an agent, which gives them the power and authority to make decisions on behalf of the company as well as vote in business decisions. For a manager-managed LLC, authority is given to managers to act as agents of the LLC. Members may be managers, but do not have to be. The key is that the members elect or appoint managers, then set out the manager's powers and authority to act on behalf of the LLC. In either situation, the powers and authority of managers should be outlined by the Operating Agreement. Should you want to grant authority or restrict the powers of these managers, you may do so in the Operating Agreement.
Corporations are another common entity option for new businesses. The main benefit to Corporations over LLCs is their familiarity with investors, bankers, and other business advisors. Specifically, if your business hopes to obtain outside financing at some point from either venture capital or private equity fund, or other outside investors, a Corporation is likely the right option for you. However, if such benefits aren’t of interest to you, Corporations are generally more complex and aren’t necessarily worth the extra work compared to a simpler form and operate LLC.
In order to create a Corporation, you first need to file Articles of Incorporation with the Secretary of State. The Articles of Incorporation are governed by Iowa Code Chapter 490, Section 202. In your Articles, you will need to include the following:
- A corporate name must be different from other names on file and must end with the word “Incorporated,” “Company,” “Corporation,” Limited,” or an abbreviation of those words.
- The purpose of the corporation
- The number of shares the corporation is authorized to issue
- The street address of the corporation’s initial registered office
- The name of its initial registered agent at that office
- The name and address of each incorporator.
In addition, Iowa Code 490.202 also allows the Articles to include various other information, such as the names and addresses of the initial directors, the purpose of the corporation, par value of the original stock, and financial compensation to be paid to directors. Once completed, this document will need to be submitted online, through the Iowa Secretary of State’s website, or in-person at the Iowa Secretary of State’s office. A filing fee of $50 will also need to be paid.
Similar to LLC’s Operating Agreements, Corporations have Bylaws, which describe the corporation’s structure, rules, and procedures for operation. These Bylaws are typically kept at the corporation’s principal place of business. They are not required by law, nor do they need to be filed with the Secretary of State. Should your Corporation not have Bylaws, Iowa Code Chapter 490 provides guidelines for business operation typically found in the Bylaws. The following subjects are typically covered in the Bylaws:
- Corporate Authority
- Meetings of Shareholders
- Directors rights and authority
- Officers rights and authority
- Capital Stock issuance/sale
- Dividend distributions
- Corporate Record Keeping
- Amendments to the bylaws
Bylaws are typically more complicated than Operating Agreements due to the increased complexity of Corporations over LLC’s. Though it is possible to draft your own Bylaws, it is highly recommended to seek legal help to draft them.
Corporations also differ from LLCs in their management structure. Shareholders of the Corporation nominate a board of directors. The board of directors’ job is to oversee corporate affairs and to handle major decisions such as major purchases or the sale of most or all of the business’s assets. The board does not handle daily operations. Instead, the directors elect officers (CEO, CFO, President, Vice President, etc.) to manage the day to day operations of the business.
Federal Tax Identification Number (EIN)
Finally, most new businesses will need a federal tax identification number or an EIN. You can think of this as a Social Security Number for your business. Both banks and the IRS use this number for tax purposes and banking services. Additionally, other businesses you do business with may require your EIN.
Getting an EIN number is fairly easy. There is a short, 3 step process to apply for an EIN. First, you need to be eligible. To be eligible, you need to have a business in the United States and have a valid Social Security Number to apply. Next, you need to complete the application on their website. The application will go over what legal entity you are, where you are located, whether you have employees, how many members you have, and your name/address. Finally, once the application is complete, you will submit it through their website and you will immediately get your EIN. Click here to reach the IRS website where you can apply for the number.
Make sure to keep this information for your records. As noted, you will use this number for your taxes, opening bank accounts, and doing business, specifically if you choose to open accounts with other businesses.
This is a very brief overview of two business entity options for a start-up or small business. Depending on your situation, the tax effects of different entity types is also an important issue to consider. With whatever option you choose, make sure further research and consultation are done in order to properly get your entity formed and operating. Once completed, your new business will enjoy certain liability protections and structure that it otherwise would not have. Though it is just one step in starting a business, it is among the most important considerations to make.
Starting a new business is a difficult process. Should you have any legal questions, need help drafting any documents, or need to settle any other legal issues with your business, LaMarca Law Group, P.C. is here to help. Our firm offers a broad range of legal services and can provide legal consultation both in starting and operating your business. Contact us at (515) 705-0233 to set up your free consultation.