agent for service of process. The person formally designated by a business entity to receive notices from the state and service of lawsuits. All states require that the agent of service of process be a state resident, and usually require the agent to have a street address (no P.O. boxes). The business owner may serve as agent for service of process, or a service provider can be hired to avoid disclosing the owner’s home address. If you plan to name someone other than yourself as agent for service of process, it is vitally important that he or she know about and agree to the arrangement, and that they know to notify you if their address changes. Some states require agents for service of process to submit a separate, signed consent to the appointment.
articles of incorporation (also: certificate of incorporation). Formal, legal document filed with the state’s Secretary of State to cause a corporation to be formed.
capitalization. Refers to how a company’s owner has paid for his or her share of the company’s ownership. In many states, paying real value for ownership rights (as represented by a LLC’s membership interests or a corporation’s shares) is an important part of properly organizing a legal entity and preserving limited liability protections.
C corporation (also: C corp). The name used to describe a corporation that is treated as a separate taxpayer from its owner for federal income tax purposes. Corporations are automatically C corporations when they are formed; they must file special paperwork with the IRS and state tax authorities to be treated differently (see: S corporation). The name comes from the section of the tax code covering such entities (Subchapter C).
certificate of organization (also: articles of organization, certificate of formation). Legal document filed with a state’s Secretary of State to cause a LLC to be formed.
close corporation. A special form of corporation that allows the corporate shareholder to directly manage the company. Not available in all states.
company. A generic term that can refer to any type of business, however it is organized.
contract. An enforceable bargain between or among two or more people (including corporate “persons”) in which one or more person has made a promise to do or not to do something in exchange for consideration, and the parties have manifested their mutual assent.
corporation. A legal entity formed by filing appropriate paperwork with a state’s Secretary of State office. A corporation’s key characteristics are: (1) limited liability of its owners (see: shareholder), (2) management by a board of directors, and (3) separate tax treatment by default (see: C corporation) with an option to be treated as a pass-through entity (see: S corporation).
creditor. A creditor is anyone who is owed money. Ordinarily, a business’s creditors will fall into two categories: (1) lenders and (2) service providers that the business owes money to. A creditor can also be someone who has successfully sued the business and has received a court judgment for a cash award. Creditors who are not paid on time can seek to recover what they are owed through legal means (lawsuits) or by using the mechanisms available to them through contract (for example, they might put a lien on real estate or a car that is owned by the business or its owner).
director. An individual elected by a corporation’s shareholder(s) to manage the day-to-day affairs of the company. A corporation’s sole shareholder can also be its sole director.
double taxation. A situation where a business entity pays separate income taxes from its owner, who also pays income taxes on any distributions from the business. Although double taxation can result in lower net earnings, in some situations double taxation can be an advantage.
fiduciary duty. An obligation a company’s directors, managers, and/or officers owe to the company and its ownership. Fiduciary duties include the duty of loyalty and the duty of care.
fictitious business name statement. A document that is typically required to be filed with business license applications for businesses that will use a name other than the owner’s personal name.
franchise taxes. Special annual taxes imposed by many states on legal entities. Franchise taxes can be thought of as the price the state puts on the privilege of doing business in the state.
freelancer. An individual professional who works for clients on a contract, project-by-project basis.
general partnership. The default form for a business owned and operated by two or more people (each a general partner) who have not organized a separate legal entity. A general partnership’s key characteristics are: (1) comes into existence as soon as its owners begin to do business, (2) joint and several personal liability of its owners, and (3) each general partner has equal authority to bind the company.
governance. Generally refers to the management of the business organization itself. Includes the company’s organizing documents, the records of its owners and managers, and the steps required to maintain the company in good standing with the state where it is organized.
incorporator. The individual who signs and submits a corporation’s articles of incorporation to the state. The incorporator bears personal responsibility for the corporation until the corporation’s shareholder and board of directors are put in place.
indemnification. A promise by a company to assume any personal obligations of the company’s officers or directors that arise in connection with their work for the company. Such obligations can include legal fees associated with defending against litigation, but can also include smaller things like administrative fees and other expenses. For example, an officer who gets a parking ticket for failing to feed a parking meter because she is in a meeting with a big potential client can ask the company to cover the cost of the parking ticket. But take care: administrative fees like parking tickets aren’t tax deductible as a business expense,1 though attorney fees and other costs related to fighting a ticket probably are. For a freelance business, unless state law requires the company to indemnify its officers or directors, chances are that it isn’t necessary or desirable to have an indemnification clause in the company’s formation documents. It usually only comes up if outsiders will be serving in a management role.
limited liability. A limited liability business entity shields its owners from personal liability for the debts and obligations of the company. The scope of limited liability is discussed in Chapter 5.
limited liability company. A legal entity formed by filing appropriate paperwork with a state’s secretary of state office. A limited liability company’s key characteristics are: (1) limited liability of its owners (see: member), (2) ability of its owners to directly manage the affairs of the business, and (3) pass-through tax treatment by default, with an option to elect to be taxed separately.
limited partnership. A legal entity formed by filing appropriate paperwork with a state’s Secretary of State office. A limited partnership’s key characteristics are: (1) limited liability of its limited partners, who do not have direct management authority over the company and (2) unlimited liability of its general partner, who manages the business on behalf of the limited partners.
member. The owner of a limited liability company.
membership interests. The unit of ownership in a limited liability company. Can be expressed in whole values (e.g., 10 units) or as a percentage (e.g., a 100% membership interest). A limited liability company’s organizing documents determine how membership interests are issued, valued, and documented.
merger clause. Language in a contract providing that the contract contains the complete agreement between the parties, regardless of promises made outside the contract. A helpful way to avoid confusion about the full scope of a deal.
operating agreement (also: limited liability company agreement). The primary governing document of a limited liability company. Sets out the rights and duties of the company’s member, determines how the company will be managed, and specifies various mechanics of the company’s governance.
officer. Any individual who is appointed by a company’s governing body to carry out specific duties. Any kind of business can appoint officers. A freelancer might want to take the title of President of his or her business, though more creative titles can be used if desired.
pass-through tax treatment. An entity that federal and state tax law treats as a pass-through vehicle does not pay separate income taxes from its owner. Instead, the owner reports the profits and losses of the company on the owner’s personal income tax returns. Keep in mind that pass-through treatment is only related to income tax, and may not apply to other kinds of tax, like franchise taxes. Pass-through entities are sometimes referred to as being disregarded for tax purposes.
par value. A minimum cash value of each share of the company’s stock, typically a trivial value, such as a tenth of a penny ($0.001) per share or even less. Some states require a corporation to assign a par value to its shares. It is specified in the company’s articles of incorporation. If the company has specified a par value, a shareholder must pay at least that amount for shares to be considered properly issued. Modern corporate statutes have done away with the antique notion of par value, but if your state requires it, it is important to make sure that the par value is built into the amount you pay for the company’s shares.
personal liability. In the context of business entities, personal liability means that the owner of a business is directly responsible for all of the obligations of the business, from fees owed to service providers to debts owed to creditors. Where personal liability applies, the owner’s assets (home, car, savings) are at risk of being taken to pay debts to creditors. Sole proprietorships and general partnerships are the two most common types of business entity that impose personal liability on their owners.
preamble. A contract’s opening paragraph. Usually includes the contract’s date and the names of the parties.
S corporation, or S corp. A corporation that has elected to be treated as a partnership or pass-through entity for federal tax purposes, by filing the appropriate paperwork (see: Subchapter S election) with the IRS. State tax authorities may require a similar election to have federal treatment applied at the state level.
securities. A representation of a passive ownership interest in a company, such as stock of a corporation. State and federal laws tightly regulate the offer and sale of securities.
shareholder (also: stockholder). An owner of shares of stock of a corporation. To become a corporate shareholder, one typically needs to pay value for the shares, and the company’s formal records must reflect the ownership. A corporation that doesn’t follow the formalities necessary to complete the issuance of shares to a shareholder can lose its limited liability protections.
stock. A corporation’s units of ownership. Also referred to as shares. A corporation’s stock is a form of security that is subject to securities laws.
sole proprietorship. A business owned by one person and not organized as another, more formal business entity type. A sole proprietorship does not exist apart from its owner, who bears personal, unlimited liability for the business’s obligations.
subchapter S election. A form submitted to the IRS that causes a corporation to be taxed like a partnership (or sole proprietorship) for federal income tax purposes (see: S corporation).
trademark. A word, phrase, drawing, or combination of these that is used in commerce to indicate the source of the good or service.
written consent. A document that formally memorializes an approval of actions to be taken by the company. For a limited liability company, written consents are signed by the company’s member. For corporations, written consents might be signed by the shareholder (for example, to appoint a director) or by the company’s board of directors. Written consents take the place of holding meetings, and are a common governance strategy for small businesses.
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1 “No deduction shall be allowed . . . for any fine or similar penalty paid to a government for the violation of any law.” INTERNAL REVENUE CODE, 26 U.S.C. § 162(f) (2017).