When starting a business, there are certain principles an entrepreneur should consider in order to lay the groundwork for a well-run and solid entity. Skimping on these key fundamentals typically creates problems that end up being painful and very expensive to fix later, if they can be fixed at all. Entrepreneurs should initially invest the time and money to safeguard against these issues by (1) acquiring proper upfront legal advice in forming the business entity; (2) proper written documentation and business records of the entity from the beginning; and (3) seeking proper accounting advice at the time you form the entity.
The way an entity is structured can have a huge impact on its future, particularly when it comes to a liquidity or exit event. Properly forming the entity is not only a strategic move but also a crucial step that will impact the financial and legal outcome when you are ready to bring in an investor or sell the company.
Foundation for future success
Behind every business is its legal structure (proper or improper). Whether it was formed as a corporation, limited liability company or partnership, each entity type comes with its own set of legal implications and tax consequences. A well-structured entity can offer significant benefits, including liability protection, tax advantages and operational flexibility. Conversely, a poorly-structured entity can create issues that may be difficult to resolve later, especially during a liquidity or exit event.
Liability protection
One of the main reasons for forming an entity is to protect personal assets from business liabilities. A properly-formed entity separates entrepreneurs' personal assets from the business assets, thereby reducing personal risk. When starting out, most entrepreneurs do not understand, so tend to ignore, the issue of separation of personal assets from business assets. For example, many entrepreneurs will use their personal bank accounts as business bank accounts. Business and accounting records should always be separate from your personal records to reduce the risk of your personal assets being exposed to claims and liabilities of the business.
Tax implications
The tax treatment of an entity can significantly influence its financial health and the outcome of an exit event. Properly forming an entity involves planning for tax efficiency and ensuring compliance with both state and federal tax regulations. Understanding these implications can minimize tax liabilities and optimize profitability, which ultimately makes a business more attractive to investors and buyers. Working with a good accountant from the beginning will save you significant headaches and money in the long run.
Compliance and documentation
Compliance with legal and regulatory requirements is important from the beginning. This includes proper documentation and maintaining accurate records. A well-documented entity can facilitate a smoother liquidity event or exit by ensuring that all legal requirements are met; there are no surprises during due diligence; and that the process is transparent. Inadequate documentation or failure to comply with legal requirements can lead to complications during a liquidity or exit event.
Perception and credibility
A properly-structured entity enhances a business's credibility and will make the business more attractive to potential investors or buyers. It signals that the business is well organized, well run, compliant with legal and regulatory requirements and will continue to be successful after the investment or after its purchase. This perception can significantly impact an investor's or buyer's confidence and, ultimately, the purchase price and other terms of the deal.
Professional guidance and legal expertise
Given the complexities involved, seeking professional legal advice during the entity formation phase can create lasting value. Lawyers with expertise in entity formation and liquidity or exit events can provide fundamental guidance that will help you maximize the value of your business.
Properly forming a business entity is not just a foundational
step; it is a strategic decision that can influence the
business's current operations and future sale. By investing in
legal representation to ensure that the entity is properly formed,
entrepreneurs can position a business for operational success,
enhance the business's valuation, attract potential investors
or buyers and achieve a smoother transition. 
Originally published by Utah Business.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.