Two friends are working on starting up a business. What is/are the best legal forms for the business?

This is a tough question to answer without more information -- so my first piece of advice is to talk to your lawyer and your accountant to get a better sense of what would make the most sense from a structural, accounting, and tax perspective. There isn't a one-sized-fits-all approach to the structure -- so it is worthwhile to take the time to give more details about your ultimate goals, how you plan to capitalize the business, and the likely financial performance of the business. Spend the time to have that conversation -- it is worth it to save you a headache down the road.

That said, I recently wrote a short article on some "Rules of Thumb" related to entity selection: http://www.myhightechstartup.com/2009/01/13/rules-of-thumb-matching-the-right-business-entity-to-your-business/#more-126 Take a look at see if this provides you further insights (I'd encourage you to read the whole post -- this is just a summary below):

RULE ONE
If your business is a one-man or one-woman company and you are making a profit that is in line with what your salary would be if you were not working for yourself, consider forming a single member LLC.

RULE TWO
If your business is a one-man or one-woman company and you are making big profits (in excess of a typical salary you’d earn working for someone else), consider forming an S-corporation.

RULE THREE
If you are unsure if you’ll ever pursue venture capital financing and, if you were to pursue it, believe you’ll wait a couple of years, consider forming either an S-corporation or an LLC.

RULE FOUR
If your business growth strategy involves raising money from investors in the upcoming 6-24 months, consider forming a C-corporation (but remember, you can form a C-Corporation and make an S-Corporation election with the IRS until you are ready to raise funding).

RULE FOUR (PART II)
The second part of this Rule is the S-Corporation. Let’s assume you fall under Rule Four, and plan to raise funds in the next 6-24 months, but you’ve got nothing certain at this point. So what should you do?

Herein is why the S-Corporation can be ideal compared to forming an LLC. If you are planning to raise funds, you can form a C-Corporation (let’s say in Delaware, which is probably the most common place for high-tech companies to form). To make that C-Corporation into an S-Corporation and have pass-through taxation, you simply need to file an S election with the IRS and follow the rules related to S-Corporations. That’s it. And then, when you are ready to take funding and issue preferred stock, you simply with forgo the S Election with the IRS, and you’ll automatically convert back into the C-Corporation. (You will need to handle some tax issues related to the change, but you’d have to do that if you were an LLC.) So for ease of operations, S-Corporation can be ideal.

RULE FIVE

If you are planning to create a high growth company in need of substantial outside funding, consider incorporating in Delaware.