The reason having multiple companies makes attracting investors easier is that multiple companies offer greater protection of their investment.
Most of the risk in your business comes from the operations side (contracts and people). By moving the operations risk away from your collateralized assets, your lenders and investors can more easily recover their money if need be. That makes them more willing to invest (through equity purchase or loan).
The owners of my former consulting business started up a new company almost every time they made a new real estate investment or bought an existing business. Our poor bookkeeper must have been running the books on at least 10 companies. When the owners decided to go their separate ways, splitting their holdings up turned out to be quite simple as each business contained a single asset. They didn't have to move assets between businesses.
Types of Corporate Structures to Consider
Several business structures have been legalized by U.S. tax law and judicial case law. Each has advantages and disadvantages.
Generally, the greater the asset protection the worse the tax hit. We are going to briefly explain the pros and cons of the four most common business structures for contractors.
- Sole Proprietorship
- "C" Corporation
- "S" Corporation
- Limited Liability Corporation
What It Is:
You are operating a business without any legal separation from your personal assets. Sole proprietorships are far more common than they should be.
Easy to get started with minimal reporting requirements. Zero start-up costs.
All debts of the business are debts of the owner (including those created by lawsuits). Sole proprietorships enjoy far fewer tax deductions than do incorporated businesses. They offer virtually no asset protection.
Due to the ease and low cost of incorporating a business ($500 +/-), sole proprietorships should be avoided. Don't let their ease of getting started blind you to their danger.
What It Is:
The standard form of incorporation in America. The C corporation is a completely separate entity from its owners.
The C corporation is the ultimate in personal asset protection for the owners and managers. The C corporation's legal obligations apply to the corporation, not to the employees who run it nor the individuals who own its stock - except in extreme cases of mismanagement (see Enron).
This protection is commonly referred to as the "corporate veil." Piercing the "corporate veil" refers to an attempt to get to the assets of the owners. Piercing a C corporations' veil is quite difficult and usually requires the finding of owner fraud. Fraud accusations are very tough to prove.
Another advantage of the C corporation is that it allows the owner(s) to install an Employee Stock Ownership Plan (ESOP) that minimizes income taxes and funds the eventual buy-out of the owner.
The primary disadvantage of a C corporation is double taxation. The company pays taxes on its income. Then, any left over money that is distributed to its owners is taxed as personal income to them.
What It Is:
A subchapter S corporation is a special form of C corporation that transfers the income tax liability directly to its owners' tax returns. This means that the company's income reaches its owners' pockets with less tax being taken out by the government.
An S corporation is usually bound by the same laws as the C corporation. Like the C, it is considered a unique entity separate from its owners.
All actions taken by the controlling managers must be in the corporation's best interest. When attacked by outside agents, this rule comes into play if one of the owners has withdrawn money that could or should have gone to a lender.
In many ways, the S corporation is the best of all worlds. Its tax advantages are fantastic while it performs well as a barricade against lawsuits reaching the personal assets of the owners.