The Basics of Business Formation: What Every Entrepreneur Needs to Know

Starting a business is exciting, but before you start selling products or offering services, you must make some fundamental decisions. One of the most important is choosing the right legal structure.

Why Business Structure Matters

Deciding on the appropriate business structure is essential for protecting assets, managing taxes, and attracting investors. Different structures offer varying levels of liability protection and operational complexity, making it crucial for entrepreneurs to evaluate their options carefully. As Robert Londin, partner at Jaspan Schlesinger Narendran, notes, businesses that make these decisions carefully and early will thank themselves later. By leveraging expert insights and understanding the legal landscape, entrepreneurs can set themselves up for long-term success.

A general partnership, for example, is the simplest way for two or more people to start a business together, but it also means unlimited personal liability. If the business gets sued or runs into financial trouble, the owners’ personal assets are on the line. General partnerships can be risky because any partner’s actions can bind the whole business and expose all partners to risk.

Instead, many businesses opt for a Limited Liability Company (LLC) or corporation (C-corp or S-corp) to separate personal assets from business liabilities. LLCs are popular for their operational flexibility and pass-through taxation, whereas corporations — especially Delaware C-corps — are preferred by investors and venture capital firms due to strong corporate governance structures and well-established legal precedents.

Key Factors in Choosing an Entity

Before settling on a business entity, entrepreneurs should assess how their structure aligns with their long-term goals. Liability, taxation, and the ability to raise capital are just a few of the critical considerations. Here are some questions to consider:

• Liability Protection: Do you want to shield personal assets from business debts and lawsuits?
• Tax Treatment: Would you prefer pass-through taxation (LLCs and S-corps) or double taxation with corporate tax benefits (C-corps)?
• Investment Needs: Will you be raising capital from outside investors? If so, a C-corp may be the best choice since it allows for different classes of stock and easier transferability.
• Management Structure: Do you want flexibility (LLC) or a structured board and officers (corporation)?

David Lopez-Kurtz of Croke Fairchild Duarte & Beres emphasizes that business goals should drive entity selection.

Funding Your Business: Debt vs. Equity

Once the legal structure is in place, the next step is funding. Raising capital is one of the most challenging aspects of starting a business. Entrepreneurs typically choose between debt and equity financing, each with its own set of advantages and disadvantages. As Gary Chodes, CEO of the National Law Review, points out, most startups don’t qualify for traditional bank loans because they lack assets or steady revenue. Instead, many turn to equity financing, where investors provide capital in exchange for ownership stakes.

Debt Financing

Debt financing involves borrowing money that must be repaid with interest. Traditional business loans, lines of credit, and Small Business Administration (SBA) loans are common sources. While this form of financing does not dilute ownership, it creates financial obligations that can strain cash flow. Entrepreneurs should carefully assess whether they can meet repayment obligations before taking on debt.

Equity Financing

For high-growth startups — especially those in tech or biotech — venture capital firms and angel investors are key sources of funding. However, raising money means giving up some control.  Zane Johnson, founder of MZA Legal, notes that equity financing can be cheap at the beginning but expensive in the end. It doesn’t require immediate repayment like debt, but it does mean sharing future profits.

Entrepreneurs should also be mindful of legal agreements related to equity, such as:

• Tag-Along Rights: These protect minority shareholders by allowing them to sell their shares when majority shareholders sell theirs.
• Drag-Along Rights: These provisions allow majority shareholders to force minority shareholders to sell in the event of a company sale.
• Dilution Protections: Convertible preferred shares often have protections against dilution in subsequent funding rounds, which is crucial for early investors.

Understanding shareholder agreements and operating agreements is vital to avoiding future disputes, maintaining stable corporate ownership, and handling management decision-making and governance.

Protecting Your Business: Intellectual Property and Governance

Safeguarding intellectual property (IP) and establishing sound governance practices can significantly impact a business’s success. IP protection ensures that innovative ideas remain exclusive to the company, while governance structures help maintain operational stability. Michael Weis, attorney at Weis Burney, stresses that patents, copyrights, and trademarks can provide a competitive edge and increase business value.

Intellectual property protection is another critical aspect of business formation. Entrepreneurs should work with IP attorneys early on to safeguard their innovations, including the following IP protections:

• Patents protect inventions and proprietary technology for up to 20 years.
• Trademarks safeguard brand names, logos, and slogans.
• Copyrights cover original creative works, such as software code and marketing materials.

Failing to secure IP rights early can result in expensive legal disputes or even loss of competitive advantages. In addition, strong governance structures are essential, particularly as businesses grow. Having clear agreements in place for decision-making, dispute resolution, and exit strategies can prevent conflicts among co-founders and equity investors down the line.

Tax Implications of Business Structures

Tax obligations vary widely depending on the business structure chosen. Understanding how each entity is taxed helps business owners make informed decisions that align with their financial goals. Taxes are a major consideration when choosing a business entity, and entrepreneurs should consider both federal and state tax implications, as well as the jurisdiction of formation:

• Sole Proprietorships and Partnerships: Subject to self-employment taxes on all income.
• LLCs: Can be taxed as a sole proprietorship, partnership, S-corp, or C-corp, providing flexibility.
• S-Corporations: Avoid double taxation but must adhere to restrictions such as a 100-shareholder limit and US shareholder requirement.
• C-Corporations: Pay corporate taxes on earnings, but owners only pay personal taxes on dividends, which can be advantageous for reinvesting in growth.

Consulting a tax professional can help a business determine the most tax-efficient structure based on business goals.

Final Takeaways

Starting a business isn’t just about having a great idea — it’s about laying a solid legal and financial foundation. Entrepreneurs should carefully choose their business structure based on liability, taxes, and investment needs. Seeking professional legal and financial advice can help businesses avoid costly mistakes when it comes to establishing clear governance agreements, protecting their intellectual property, and understanding the trade-offs between equity and debt financing.

To learn more about this topic view The Start-Up/Small Business Advisor / The Very Basics: Forming the Business. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about business formation for entrepreneurs and startups.

This article was originally published on March 6, 2025.

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