Online Incorporation and LLC Formation Services

Online Incorporation and LLC Formation Services – Advantages and Disadvantages, Pros and Cons

Online incorporation services tout easy, fast, and cheap online incorporation and limited liability company (LLC) formation services. Examples include LegalZoom.com, MyCorporation.com, and IncorporateTime.com. Storefront and virtual paralegal services such as We the People and those found in the legal services section of your local craigslist also offer similar services.

Their web sites and radio and TV sales pitches indicate that forming a corporation or LLC is as quick, easy, and inexpensive as filling out an online questionnaire and paying a fee of $100-150 for the completion of the paperwork and the filing of the documents with the secretary of state (plus the filing fees charged by the state).

This article reviews the advantages and disadvantages of these services overall – for specific reviews of a particular provider, you should look elsewhere (and preferably to those with direct experience using the service, as well as at least a year of business operations thereafter).

No legal advice

In the fine print, many document preparation services state they are not law firms, cannot provide legal advice, and recommend that you consult an attorney for legal advice. Here’s a word for word example from one web site: “This site is not a substitute for legal counsel…. You should consult legal counsel to determine applicable law for your situation.” And from another: “[Our document preparation service] is not a substitute for an attorney or law firm.”

Only licensed attorneys can practice law and provide legal advice to clients, so these firms are wisely protecting themselves by making it clear that they are not in the business of providing legal advice; they are in the business of preparing whatever forms or filing you tell them to. Thus, the computer programmer’s old adage, Garbage In, Garbage Out, applies.

If you tell them to form a Nevada LLC, when you really need a California S corporation, they will in all likelihood produce a technically sufficient LLC, but it won’t meet your actual business legal needs. Likewise, if you choose not to elect S-corporation status, and end up paying higher taxes as a C-corporation, this is not their fault; they are counting on you to know what you need, or to have consulted a lawyer and/or tax accountant before coming to them.

Many incorporation services would apparently seem to remedy this situation with lengthy FAQs and learning centers, but, frankly, a few minutes or even a few hours of research is not a substitute for a lawyer’s college degree, three years of law school, and additional on-the-job training and annual continuing legal education.

Any paralegal or incorporation service whose employees do provide legal advice is engaged in the unethical practice of law without a license, a crime in most jurisdictions, and their legal advice, for more reasons than one, should be taken with a grain of salt. Better yet, terminate your relationship with any such person immediately.

The other ‘remedy’ is to portray incorporation as a one size fits all, cookie cutter purchase, rather than explaining the reality that can be summed up the quote sometimes heard in law school, “The general rule applies to no one in particular.” In other words, your circumstances and needs are not those of your friends, neighbors, or other online entity formation customers.

Other Legal Issues

Attorneys will focus not just on forming an entity you have ordered them to, but in taking a step back, assessing your overall business plan and goals, and making sure the legal structure takes into account your particular circumstances, rather than assuming you and your business are exactly the same as the next guy and his business.

They will also at least point out, and suggest options for best addressing, legal issues that arise tangentially to forming a corporation or LLC. Such issues that the average incorporation service customer may be blissfully unaware of include securities laws compliance, promissory notes, trademark and service mark issues, and employee and independent contractor law.

(Tax issues are also inherent in incorporating, so working with a CPA or accountant is something I always recommend to clients before and after incorporating.)

Agreements typical of new corporations or existing business which are growing and have decided to incorporate include employment agreements, independent contractor agreements, supplier agreements, web site terms of use and privacy policies, and shareholder buy-sell agreements. All of these should be customized to your needs, not fill in the blank forms, just as corporate bylaws and LLC operating agreements should be customized, not one size fits all.

Lack of Follow-Through

A good business attorney will also assist you in following through in the formation of your corporation or LLC. By this I mean making sure the meeting minutes are appropriately customized to your needs and the corp. or LLC’s formation documents are actually completed, signed, shares are actually issued to shareholders, and appropriate federal, state, and local filings are made.

After having reviewed numerous incorporation service companies, usually a year or more later after problems have arisen, but also often times in the course of transactions such as sale of the business or part of it to a new shareholder, member, or partner, I have yet to see a company that was correctly set up. I can say the same of do-it-yourself incorporations, where the owner(s) didn’t hire anyone and did it themselves.

In most cases, the articles of incorporation (for LLCs, the articles of organization) have been completed and filed in an adequate, if not optimal, manner, and the bylaws or operating agreement is likewise present. However, such documents are generally never executed – they just sit on the shelf in a binder, as they have since they were mailed out by the incorporation service, and thus without any force or effect whatsoever. Frequently, they contain numerous blanks that the owner was supposed to fill in, but didn’t because they didn’t know how to, or just never got around to it.

These defects are not the fault of the incorporation service per se, but they are indicative of the different level of service provided by such companies, in comparison to an attorney. Such lack of completion can and does lead to problem later, however, because the company’s limited liability status and good standing with the state can be jeopardized by missing or incomplete corporate documents, or by failure to create annual minuets and file initial and annual state level filings.

Difficulties also occur when disputes among partners or co-owners later arise, and upon review of the bylaws or operating agreement, the parties find that the documents were never signed (and thus may not control), that they lack buyout procedures, or that they are vague or silent on how to handle disputes. It goes without saying that most of these disputes are much more costly to resolve later, once the proverbial horse of improper documentation and agreements has left the barn.

Hidden fees

The main benefit of incorporation services is costs savings; they charge less than attorneys do.

However, the actual fees charged by incorporation services often ends up being as much as two or three times higher as they low rates they advertise, once such “add-ons” (which in many cases are needed to achieve your legal aims) as name reservations, corporate minute books, expedited or rush service, EIN numbers, S-corp election, first meeting minutes, and initial statement of information, sales tax reseller’s permit, business license, or other state or federal filings are made.

So be sure to check what a complete package costs in making comparison amongst various providers and versus law firm fees. Some services I’ve seen on craigslist.org offer rates so low, they do not even account for the minimum level of costs that must be expended to properly set up a company! (E.g., $125 including costs for a California incorporation – the government fees alone are at least this high, let alone any third party service fee.) In many but not all instances, law firms offering flat fee incorporations do not have hidden fees.

In any case, the important consideration here is that incorporation service prices cannot and do not include legal advice on the incorporation process or related legal issues, hand-holding, referrals to other professionals such as accountants and insurance agents, or follow-through to ensure that the business entity is actually implemented correctly.

Upon seeing all the work that goes into an incorporation or LLC organization, the most common remark from my clients is not, ‘That was easy; I should have used an incorporation service, saved your legal fees, and done it myself.’ Rather, it is, ‘I can’t believe some people try to do all this themselves!’

You should keep in mind the difference in the level or services provided when evaluating price, be on the lookout for hidden or additional fees beyond the base rate, and realize that if you are choose to select an attorney over an incorporation service, you are paying not only for that attorney’s time and end work product, but also his education, experience, skill, and legal advice and counsel for your business.

Relationship with a lawyer

In deciding to go it alone, you should keep in mind that sooner or later, if your business grows, you will need a business attorney. It may be more prudent to establish that relationship now via an incorporation and set yourself up for future growth and success, rather than wait until a legal emergency arises, only to find you don’t know any attorneys, or that the attorney you do retain finds that there are numerous steps you could have taken in the past to avoid current fees, taxes, problems, and disputes.

The fact that these problems don’t become apparent until months or years after the company’s formation (especially if professionals such as attorneys and accountants are never hired and thereby given the opportunity to review the company and spot issues) means that many customers of incorporation services are initially well pleased with the service they have received. If you don’t know what you didn’t get, you have no reason to be unhappy about; instead focusing on the money saved now.

In my experience, rarely does money saved on legal services now pay off in long-term savings. More often, it’s the old, pay now, or pay (more) later situation. Some errors, such as choice of entity decisions that were not tax favorable, cannot be undone, they can only be changed going forward. Likewise, after a shareholder or partnership dispute has arisen, it’s usually too late for proper buy-sell provisions in the bylaws or operating agreement, a separate buy sell agreement, or an arbitration clause.

If you don’t have enough money to afford an attorney at the outset, perhaps you and your partners should consider committing additional funds to the enterprise, utilizing loans or credit cards to access additional funds, or wait until more financing can be accumulated or obtained, before proceeding in a less than optimal way.

Most entrepreneurs are convinced of the future growth and profit prospects of their companies; thus, it is surprising they often don’t follow in the footsteps of other successful enterprises and allocate appropriate funds for legal services. The adage, “Failing to plan is planning to fail” applies here.

A good business attorney will also be able to provide referrals to reliable accountants, insurance agents, and others services new businesses are likely to need.

Volume business

Incorporating services are sometimes called incorporation mills. By their very nature, they are in a volume business; they cannot charge low prices and provide personalized attention or service. In general, they make their profits by selling a non-customized or a minimally customized product over and over to as many customers as possible. Law firms, on the other hand, provide customized legal advice and services to each client on an individual basis.

Law firms can handle unusual capital, profit, loss, or other allocation issues that fully and correctly utilize corporations and LLCs, and advise when such use is appropriate and when it is not. Incorporation mills will, for the most part, sell you whatever you ask for; it’s your responsibility to determine whether you are ordering the right product from them.

But aren’t you, as a California incorporation lawyer, biased?

That’s certainly a legitimate question, and I obviously have a strong opinion on the matters discussed. It’s up to you to take to heart or disregard the opinions and advice in this article, but I would answer it this way: Because I am a business attorney, I have seen the result of using these services in a way most lay people would not, and as a result cannot recommend that most people use an incorporation service.

And although incorporation legal services is part of my business law practice, I would encourage most readers to use an attorney of their choosing, in their state – it need not be me and obviously I don’t benefit from you using another attorney any more than I benefit from you using an incorporation service.

In fact, incorporation services are probably in the long run good for my practice; they provide a steady stream of repair work and dispute resolution for me, that typically cost $1000s more than my flat fee incorporation services.

Summary and Conclusion

In short, comparing incorporation services to a business lawyer is an apples to oranges comparison. One option provides more services and costs more; one provides less and costs less. Neither is a “rip-off” or the definitive solution for everyone. You are more likely to get things right by choosing either than choosing neither and going it alone.

The lawyer is licensed by the state to provide legal advice, is subject to numerous ethical rules, forms an attorney-client relationship with his clients, and keeps up to date on changes in the law through mandatory continuing legal education. The incorporation service simply executes on your instructions, no advice, no hand-holding, no legal review of your situation or legal needs. If your instructions do not comport with what’s best for your situation, then your result will be less than optimal.

There may be a small group of people who know what they need, and how to do it, but just lack the time, and who are thus well served by incorporation services. (Ironically, most of these people probably realize the value of an attorney’s input and would generally hire one to take care of their legal needs, while spending their own time on what they do best, improving their business. This explains why I have business entity formation clients who are attorneys and law firms!).

Or who have been advised by their accountant to form a particular type of simple entity (simple being defined as an entity to be formed in their home state jurisdiction and with only one owner).

But, in my opinion, the vast majority of potential incorporation service customers would be better served by investing an additional $500 or so to have their entity selected, formed, and set up correctly, with all of their questions answered along the way, with due attention to related legal issues, and to establish a relationship with an attorney for ongoing or future legal services.

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