WealthManagement Magazine
Starting an RIA, a User's Guide to Picking the Right Business Model

Starting an RIA, a User's Guide to Picking the Right Business Model

When it comes to setting up your own RIA, there's no such thing as a one-size-fits-all model




Starting an RIA, a User's Guide to Picking the Right Business Model

When it comes to setting up your own RIA, there's no such thing as a one-size-fits-all model.

Indeed, many factors go into the decision such as your location, tax situation and business goals. "You don't want to do an LLC just because John your buddy, who is a financial advisor, did an LLC," says Christopher E. Winn, managing principal of AdvisorAssist, a service that helps advisors go independent.

As such, advisors should consult with both a securities attorney who is well-versed in regulatory requirements and an accountant for guidance in deciding which entity is best for their business. In this respect, it pays to think ahead because this can save you headaches, legal costs and tax consequences later on.

"It's very important to make the right decision at the outset," says Ralph De Martino, co-chair of the securities regulation and registration practice area at Cozen O'Connor in the law firm's Washington, D.C. office.

"You can't anticipate everything, but you want to anticipate as much as you can up front," adds Corey Kupfer, chief strategist at MarketCounsel, an Englewood, N.J., regulatory and compliance consulting firm.

As you're going through the process, consider some of the following key items: Do you expect your company to remain private or ultimately go public? How many and what types of shareholders do you expect to have? Will all owners come in at the same time or will they stagger in? Will you want the ability to change ownership without issuing new shares? Do you expect to seek funding in the form of equity in the near future? And if you're part of a team, who owns what and how is ownership shared?

Other important considerations include the pros and cons of being a W-2 employee versus taking an owner's draw. It's also important to think about local tax and fee issues based on where you are physically located. What's more, you also must consider where you want to form the corporate entity because there may be advantages to doing it outside the state in which you are located, Kupfer says.

Read on for some information about various ways you might decide to form your own business, keeping in mind that there are many intricacies to consider. It's also imperative to talk to a tax advisor and attorney before making any decision.

Sole proprietor—Someone who owns an unincorporated business by himself or herself. Most lawyers don't recommend this structure for financial advisors because the owner can be held personally accountable for liabilities of the business. So the risk is too great.

General partnership—A relationship existing between two or more people who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. Most lawyers don't recommend this structure for financial advisors because all partners are personally liable for the business.

Limited partnership—A structure consisting of one general partner with unlimited liability and limited partners, who are usually passive investors with no management control and limited liability protection. You typically set up the general partner as a corporation or another limited liability entity. This type of structure was more popular before LLCs came into play, but it's more widely used today for hedge funds, according to Kupfer of MarketCounsel.

Limited Liability Company (LLC)—By far the most flexible type of entity and one chosen by many RIAs. LLCs are popular among advisors because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership—providing management flexibility and the benefit of pass-through taxation.

Owners of an LLC are called members, and there can be any number of them. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign companies. Most states also permit LLCs comprised of a single member.

S Corporation— In certain states, tax differences between LLCs and S Corporations might make the latter more advisable, although there are various shareholder restrictions to consider. S Corporations are companies that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. S Corporations avoid double taxation on the corporate income, but they must be domestic; they can't have more than 100 shareholders and shareholders may not include partnerships, corporations or non-resident aliens. S Corporations can only issue one class of stock. Certain other corporate formalities also must be met.

C-Corporation— A legal entity that can shield the owners from personal liability and company debt. Regular corporations are bound by certain paperwork and reporting formalities, but they can have an unlimited number of shareholders, foreign citizens included. A downside is that double taxation frequently occurs because the corporation is taxed on its profits, and shareholders are taxed on the distributions they receive. For this reason, C Corporations are generally not a popular choice for advisors; however, those who need funding and expect to go public in the foreseeable future might research this option further.

For more information on any of these options, visit the Internal Revenue Service's website at www.irs.gov.

Questions or feedback? Please email us at [email protected].

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