Forming a business is exciting, challenging and sometimes frustrating. It is an early hurdle for a hotel owner because it is the moment when a dream bumps into reality. At that moment, you wonder if you really want to become an owner and the scope of the project can suddenly seem daunting. However, forming a business is straightforward. Once you have it in place there is something tangible that says, “this will happen”.
In the process of forming a business, you will name your new company and purchase a URL for that name so you can set up your company email. You will choose a business structure for your new company and you will create that business as a legal entity in your state. As part of that process, you will work with an attorney on the operating agreement or bylaws that define your relationship with your new company and its other participants. Then you will apply for a TIN (Tax Identification Number) with the IRS and you will be in business.
It’s a step-by-step clearly defined process. While there is a learning curve and a bit of bureaucracy to navigate, it is very straight forward. Because most state and local governments want to encourage business formation, in most places, you can readily follow these steps through well-organized online portals.
Naming your company
Your company is its own legal entity, separate from you and the hotel. It has legal rights and responsibilities and it can do business as a being. So, your company will have a name separate from the name of your hotel. The name of the company represents your interests. The name of hotel is part of marketing and branding the hotel operation itself.
It took weeks to settle on the name for Fortuna’s Table. It involved deciding what to convey, which words had an appealing sound and dropping words had undesirable connotations. Your creative exercise should give you two or three possibilities. At that point:
- Look it up on your State’s Secretary of State’s registry to see which of your choices are available for use
- Check the availability of your choices as domain names on a hosting site like www.GoDaddy.com or www.ipage.com; there are many hosting sites
- Do a Google search of your choices to avoid words in use by other companies in the industry and to select names with desirable connotations
Then you reserve your final choice with the Secretary of State, usually through a simple on-line form. Typically this is the state where you live but could be where you intend to do business. Once you are approved for the name, you register your business.
You also register and purchase the domain name so you have it ready for your email use. If you decide to put up a website for your new company, the domain name will also be ready.
Your hotel is a business and it should be housed in a legal business entity. A business entity gives you liability protection and tax benefits. Your state’s Secretary of State website should have additional information about how to register. You choose from four types of business entities based on your business requirements:
- Limited Liability Company (LLC) is a hybrid form of partnership and consists of members. Hotel owners – particularly small companies and families – commonly use an LLC form. The LLC structure takes advantage of the benefits of a partnership in that profits and losses are passed through to the owners without being taxed at the corporate level first. An LLC avoids double taxation where you pay tax as a company and then pay tax again on the same income as a member. LLC members are shielded from personal liability, so an LLC protects your personal assets. It is relatively simple and inexpensive to set up and may be something you chose to do yourself. Because the documents and agreements to form an LLC are simple, you need an operating agreement to spell out the details. Operating agreements are commonly prepared by an attorney.
- Corporation is a legal entity separate from its owners that is created to conduct business. Like a person, a corporation can be taxed so, with exceptions, taxes are collected both from the corporation and from the individual owners. A corporation shields its owners from personal liability. Corporations have directors, officers and shareholders. There are several types of corporation. Many larger companies are C-corporations, particularly those with many employees and those that intend to sell stock as a form of raising capital. A Sub S corporation is a variation that avoids double taxation by passing income or losses through to individual shareholders without being taxed at the corporate level. It is more complex to set up a corporation than an LLC and the record keeping required is also more complicated.
- Limited Partnerships or LPs are legal arrangements in which two or more people share in the profits and losses of a business. Profits and losses flow through to the partners without double taxation. However each partner is personally liable for all the financial obligations of the business. Partnerships are a higher risk entity for the owners. Limited Liability Partnerships or LLPs have one general partner with unlimited liability and limited partners with limited liability. LLPs are sometimes used to own hotels. Partnership agreements are complex and should be designed by an attorney.
- Sole proprietorships are businesses with one owner. They do not provide a shield from personal liability. They are not well suited to owning a hotel that has investors and other stakeholders. Sole proprietorships are used by many non-employer businesses. Your business is automatically a sole proprietorship if you do not register as another kind of business. One reason it is important to set up your business formally is that you want to deliberately choose how you will approach taxes and liability.
TIN (Tax ID Number)
Once the company is formed, you can apply for a tax ID number (EIN or Employer Identification Number) from the IRS. You will need the EIN to conduct business. The EIN is like a Social Security number to identify a business. Until you have an EIN, you will use your own Social Security number on applications and forms. This makes it important to get an EIN early in your journey to ownership. Once you have the EIN, you can file for local and state licenses and permits including your business license from your city or local jurisdiction.
Once you establish an LLC, you will need an operating agreement, which is a legal document that defines how the LLC will operate. It is signed by every member of the LLC. Although an operating agreement is not a legal requirement and is not filed with the Secretary of State, it is critical to running your company well and maintaining good relationships with the members of your LLC. The operating agreement minimizes misunderstandings and clarifies everyone’s position from the beginning. Hotels are complex enough that you should consider having a business attorney from your state draft, or at least review, your operating agreement.
- To protect your legal limited liability status, you must show that your company is separate from you. The operating agreement gives credibility to your LLC and proves that it is indeed a separate entity.
- Lenders will want to see your operating agreement to know how you plan to run the business, how responsibility and finances are arranged within the LLC, and to understand how your liability is limited.
- States have default rules for LLCs which may or may not be ideal for your hotel business. An operating agreement can override some default rules.
- Operating agreements define succession plans which is an important safeguard in case of the unexpected.
- Your relationship with the members of the LLC is defined in the operating agreement so everyone understands distribution of profits, decision making authority, ownership and other aspects of your relationships. These are common features of an operating agreement:
- Percentage of ownership
- Distribution of profits
- Voting and decision-making rights
- Management structure and members roles and responsibilities
- Dispute resolution
- Dissolving the business
- Contributions and distributions
- New members and transfer of membership interests
- Signatures from all members to make the agreement legally binding
Bylaws and other agreements
If you choose to establish a corporation for your business, then you need bylaws – the legal document that specifies how the corporation will be structured and managed. The legal documents governing a corporation are the Articles of Incorporation, which are public records, and Bylaws, which are not public. Bylaws are a detailed set of rules adopted by the corporation’s board of directors after the company is incorporated. The basic components of the Bylaws are:
- The corporation’s name, purpose and location
- Types of members (if any, members are not a requirement), membership selection, voting rights and procedures for disciplining and/or removing members
- Composition of the Board of Directors, how vacancies are filled, qualifications for serving as a director, duties of directors, terms and classes of directors
- Committees that carry out the work of the Board including the Executive Committee
- Officers, who are Board members and include President, Vice President, Secretary and Treasurer as well as procedures for removing officers and establishing officers
- Meetings of the Board including frequency, notification, definition of a quorum, and other stipulations
- Conflicts of interest and how directors are obligated to address such conflicts
- Procedures for amending Bylaws
Every set of bylaws is unique and yours should be designed for your hotel company.