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Part 5: How to Select the Correct Business Classification for your A/E Firm
By now you’ve probably realized that researching management philosophies or figuring out what a multiplier is can be pretty overwhelming. There are several choices available to you when determining how you are going to operate your new A/E firm. For example, what business classification should you be? What type will work best for you and your startup? Yep, add that to the list of things to figure out. The good news is I’ve already obsessed about this for you. After all, creating something from nothing isn’t easy, so getting advice from someone who has done it successfully isn’t a bad place to start.
When talking business classification for starting your own A/E firm, you have a multitude of choices. Some you can eliminate right off the bat and some need some more in-depth analysis. To get started let’s take a quick look at your options:
1. C - Corporation
This is one of those choices you can eliminate right off the bat. When your company gets large and perhaps wants outside investors, you can look into this. I personally am going to try everything within my power to build every business I ever have without using this model. Outside money dilutes your ability to be nimble, quick, and agile, which is a huge disadvantage to a startup. Not to mention the tax implications of this model are horrendous.
2. S – Corporation
This is a solid choice for your startup. It’s what my business partner and I used to start our AE firm and have maintained to this day. The S-Corp status offers a lot of attractive options with regards to shares, payroll, dividends, branding, and taxes. My only gripe with S-Corp status is the restriction on types of stock. Each share of stock in an S-Corp is common stock which carries both financial and voting rights. This isn’t a problem at startup, but as you grow, it could limit your ability to attract and recruit higher level executives without diluting your control of the firm.
3. Limited Liability Company
This is another solid choice for your startup. This is actually what I used to start PAEVEN and will maintain for the foreseeable future. The LLC status offers the absolute best options for any business with regard to taxation and corporate shielding. Don’t like using LLC in your company? Then don’t. Use the power of “doing business as” and file with your State to name your company whatever you want and not have LLC in the title.
Absolutely no. Not even going to waste more than a sentence on this one. Any questions, email me.
5. Limited Liability Partnership
This is a solid choice as you grow, but not for a startup. Law firms like to use this model as they bring more and more “partners” into their practice. Since you are a startup and are probably still deciding whether or not you are going to have a partner don’t bother stressing out about this one. File it away as something you can look into later down the road.
Yes and no. This option offers one benefit that none of the others can – NO PAPERWORK! That being said, that is the sole reason I would recommend someone should use this system. When you are getting things together for your business, you don’t need to file all the paperwork an S-Corp or LLC will require right out of the gate. You can operate just fine as a sole-proprietor so long as you aren’t actually practicing architecture or engineering. There is no corporate protection offered with this model so if your firm gets sued, you are personally liable.
Now that we’ve hashed through the most common forms of business classification in a for-profit venture, let’s dive in a little closer to help you determine what will work best for you. To recap, your startup business classification journey should look like something like this:
1. Get everything going as a sole-proprietor first.
Don’t be opening bank accounts, signing leases, or insuring yourself as a sole-proprietor, but absolutely feel confident that you can create your business and marketing plan in this stage. You can also be looking for a business partner if you are going that route.
One important tool at your disposal during this time is the “Promissory Note.” Many people believe they have to have a company bank account or credit card to buy items for their company before it is actually a company. That is false. If you are looking to buy a computer or certain pieces of software you can do that with your personal finances, keeping a proper receipt journal of course, and then write a promissory note from yourself to your company when it is time to become an S-Corp or LLC.
2. When you are ready to roll, figure out whether you are going to be an S-Corp or LLC.
Notice how I didn’t really give you a choice here? I would say that you are free to do as you like but, I do not advocate operating a startup A/E firm outside of these two models.
Now that we’ve narrowed your operating status down to S-Corp and LLC, which one should you choose? Let’s take a look.
Some of the main advantages to an S-Corp are the intangibles that you cannot get with an LLC. For example, “Inc.” after your company’s name. For whatever reason the word “corporation” gives you a perceived legitimacy that “limited liability” does not. Even though they are both protected by the corporate veil, most outsiders looking in don’t know this and it is that perceived idea that prompted my business partner and myself to use S-Corp status for our company, Sixmo Inc.
When building a startup A/E firm I am a big advocate of eliminating as many potential hurdles as possible. Some other items that an S-Corp can help with are:
Simple and easy. Money flows directly to the owners based on their shares and is added to your personal taxes through a schedule K (your accountant will do this for you).
You are only taxed once. I know this sounds like a no brainer, but C-Corps actually get taxed twice. No wonder they are always so upset.
As a startup you can set your salary to what the government calls “reasonable.” The rest of your pay (as an owner) can come as dividends based on your ownership distribution of shares. This is important because dividends are not subject to FICA taxes, which is another 6.2% Uncle Sam can’t take to wet his beak. Typically this is not allowed in an LLC.
The company is perpetual so you do not have to continue to file paperwork with the state and/or federal government annually. Do it once and be done with it.
Limited Liability Company
The advantages to an LLC is almost an embarrassment of riches. You are afforded so many opportunities with an LLC that it really gives a strong argument against the S-Corp. As mentioned before, one of the things I like about the S-Corp is the “Inc.” status. You cannot do that with an LLC. In fact I would recommend that if you choose to go with an LLC that you exercise your right (depending on state law) to have a DBA. With a DBA you can name your company whatever you want and focus your attention on branding that name to your audience.
When starting an A/E firm you want to make sure you have some sort of growth plan in mind. Where do you see yourself in 3 years? 5 years? And so on and so forth. Choosing an LLC is a great way to do this because of its flexibility. Some other advantages are:
LLCs are allowed to have subsidiary businesses without restriction whereas S-Corps are not allowed to be owned by C-Corps, S-Corps, LLCs, or most trusts. Where this may come into play is if you were going to open a part-architecture firm, part-construction business. These should be separate so that you can maximize the tax write-offs of each business depending on how each performs respectively. If you have an LLC then your subsidiary business could be the construction company, either an LLC or S-Corp. You couldn’t do this with an S-Corp. Your subsidiary business would have to be something other than an S-Corp.
LLCs don’t have to operate like a corporation with a board of directors and officers. LLCs can freely call meetings of the owners or managers whereas S-Corps have to follow strict guidelines. If these guidelines are not followed, a lawyer could pierce the corporate veil by arguing that you were not truly acting as a corporation. You could lose the protection of the corporation in such a lawsuit.
LLCs have almost no ownership restrictions whereas S-Corps have quite a few.
LLCs can have unlimited owners whereas S-Corps can only have 100.
S-Corps can only be owned by American citizens whereas LLCs can be owned by anyone.
So what is the best option for you and your startup A/E firm? The truth is it really all depends. Being a Type-A person I don’t mind all the formalities needed for the S-Corp. At the same time, I really like the laid back way the LLC can be run. I honestly don’t feel like you can go wrong with either. The great news is that you can also change from an S-Corp to an LLC if you feel you’ve outgrown the model later down the road. If you find yourself having some specific questions you would like addressed, feel free to reach out and email me at email@example.com. I would be happy to offer advice on a more detailed level specific to your situation.
1. In the inception stages of your business, don’t run out and file official business paperwork. Be a sole-proprietor as long as you can.
2. When it is time to start your business, choose between either an S-Corp or an LLC.
3. Read up on promissory notes. They will be a huge help for you at several stages of your business.
UP NEXT >> Part 6: Open or closed books?
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