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When choosing your form of business you must weigh several factors for
their importance to you and your goals. Consider risks, your long term
plans and your resources.
Your legal form
will make a big difference for sources of financing, personal and financial
risk, taxes, workload, signing contracts, buying a business or selling
one,
debt and liability issues and more.
Consider each factor
below then consider which form of organization best meets your needs.
- Liability
- Taxes and tax status
- Sharing Profits
and Losses
- Control and Decision
Making
- Co-mingling and
Division of Assets
- Workloads
- Litigation
- Agency
- Expenses
- Starting and Stopping
- Continuity and
Growing
- Paperwork
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Sole proprietorships
and partnerships are forms of business ownership that mingle the owner's
rights, liabilities and responsibilities with the business' rights, liabilities
and responsibilities.
Sole
Proprietorships -
One owner and the owner and the business are the same legally. It is
the most common form of business. An individual owns, manages the business
and is responsible for all transactions and activities. Key characteristics
of a sole proprietorship include:
- Own and operate for any duration of time
- sell it, close it whenever the owner wants to
- pass the business to heirs
- no specific business taxes; all profit is personal income
- comply with all
license and permits necessary fir a business to operate legally;
no special "sole proprietor" paperwork or requirements
- need dba, business license if required, etc. as any business would
- personally responsible for
all debts and liabilities of the business, even after it closes until
its affairs are completed
- unlimited personal
liability; liability for acts committed by employees
- pay self-employment
taxes (Medicare. social security); business expense
- the IRS and most states expect self-employed individuals to pay
income tax throughout the year, usually quarterly estimates; failure
to so so results in fines and interest payments
- no salary expense
- eligible for Keogh
plan and other tax deferred retirement plans
Start by engaging
in business: buy, sell, open business bank account, and so on. They
are usually started with loans in combination with personal assets
and cash form savings contributed to the business operations by the
sole owner.
Advantages
of a Proprietorship
- Easy and inexpensive
to start and stop legally
- Generally less
expensive to start
- No profit sharing
- No business tax
- Owner is in charge
and makes decisions
- sell or transfer
business at your discretion
- Speed in decision
making
Disadvantages
of a Proprietorship
- Unlimited personal
liability
- Owner's limitations
(skills, time, etc) limit business
- Harder to access
capital
- Continuity of business
- re-establish all contracts and relationships is sold or transferred;
terminates with death of owner
- Personal assets
subject to lien
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Partnerships - established with written or oral Agreement. Assumed
to exist if:
- clearly perceived
intention to be one
- co-ownership or
co-interest in the business
- profit/loss is
shared
- May be implied
by actions
Operates under Uniform
Partnership Act, as modified by any partner agreements. Partnerships follow
default legal guidelines but these guidelines may be modified by a partnership
agreement.
Partnership
Legal Defaults
1. Mutual Agency - any partner can act on behalf of the other partners;
all partners fully represent the business for any action or transaction.
2. Unlimited Liability
- each partner is fully responsible and liable for the business and the
acts of the partners.
3. Three types
of partnerships:
- General
- Limited
- at least one
general partner
- plus one or
more limited partners
- liability limited
to investment for limited partners; unlimited liability for general
partners
- no management
participation for limited partners
- requires a
certificate of limited partnership and a written partnership agreement
- can allocate
profits and losses
- interests are
freely transferable
- Joint
Venture
4. Limited Life of the Legal Partnership: The partnership ends
and its affairs must be concluded:
- accomplish the
partnership objective
- admit a new partner
- withdrawal of partner
- death of partner
- personal bankruptcy
- time or date set
for dissolution
- partner incapacity
(need court decree)
- misconduct…
5. Continuity of
the Business: The partnership as a legal entity is a form of ownership
for a business but is not the business. A legal partnership may end but
the business may continue with supplier/customer agreement and business
contracts and relationships reestablished or modified to continue an existing
partnership.
6. Co-Ownership
of Property - all property, whether donated, purchased with capital
or gained through profit and growth is co-mingled. It is considered fully
owned by each partner and subject to each partners discretion for use
as an asset of the business.
7. Non Taxable
Entity - the partnership itself is not subject to taxes. The owners
each pay personal income tax based upon their respective shares of profits
and at their individual tax rates. Each partnerships profit or loss is
personal taxable income or loss.
8. Profits/Losses
equally divided - unless modified in a partnership agreement, all
profit or loss is equally divided proportionally amongst the number of
partners ( 3 partners, three equal shares)
9. Entered into
by any combination of individuals or legal business entities - A partnership
can be any combination of individuals, other partnerships, or corporations.
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A partnership agreement
should be put into writing as a contract between the partners. Partnerships
operate under the Federal Uniform Partnership Act as adopted and
modified by each state. Partnership agreements should be filed at the
Secretary of State's office in the State Capital.
The following are common terms that should be clearly spelled out unless
you want to operate under the default laws of partnership as stated above.
- Name & Term
- Purpose
- Contributions - cash, services, property
- Profits, Losses, Draws
- Payback of Loans by partners
- Authority & Decisions
Making
- Management Responsibilities
- Partners' Outside Business Activities
- Departure of Partner - Buyouts
- Continuity of Partnership
- Non-Competition of Departing Partner
- Control of Partnership Name
- Resolving Partnership Disputes
- Changes in Your Partnership
- Distribution of Assets upon dissolution
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Advantages
of a Partnership
- Easy
and inexpensive to start legally
- Greater access
to capital
- no business tax
- informal management
and structure
- Greater access
to skills, time, money, an so on.
- no written agreement
required (but advisable)
Disadvantages
of a Partnership
- Unlimited liability
of general partners
- Joint and several
liability
- Harder to keep
profit in the business for growth (Capital Accumulation)
- More difficult
to raise capital
- Changing the partnership
agreement may dissolve the partnership or be difficult
- Interest is not
freely transferable
- Personal and authority
conflicts
- Decision making
is slow, shared, and partners are bound by the law of agency
- difficult or expensive
to dissolve
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A corporation is
a legal entity, separate from its owners, with many of the rights of
an
individual: a name, enter contracts, own property, sue & be sued
and so on. (It can't get a Driver's License or Register to vote). General
characteristics of corporations include:
- Dividends
- Double taxation
- Shielded from
personal liability as "owner" (stockholders)
- Salary is expense
- Can offer fringe
benefits
- Stock:
- common
- preferred:
1st dividends & claim to assets, no vote
- many other
types of stock are possible
- Ownerships (shares of stock) freely transferable
- Domestic, Foreign,
Alien (Domestic = in state; foreign = other state; alien = other country)
- Articles of Incorporation
and Bylaws
- More difficult
to start and operate in terms of effort, paperwork, organizational structure
and meetings
- Perpetual life
- Legal requirements
include Board of Director meetings, shareholder participation and
annual reports,
etc.
Types of Corporations
"C" or
Close Corporations
- Less than 35 stockholders
- One kind of stock
- No qualifications
of securities
- Private offering
- no public advertising
"S" Corporation
- a close corporation of individuals, trusts, estates. Created by legislation
to ease corporate tax burdens; treated as a partnership for taxation.
- Deduct tax losses
personally
- No double taxation
on dividends
- Spread income within
family
- Limited to 75 shareholders
- All shareholders
must consent to S format
- No corporate or
foreign investors (individuals only)
- Must be domestic
- can't own> 79%
of another corporation
"LLC" -
Limited Liability Corporation - 2 or more "members" in
California (most states allow a single member) and has the tax advantage
of being treated like partnership by the IRS; all
advantages of an S Corp including personal liability and debt protection.
Unlike a corporation it is free of legal requirements such as annual
reports, director meetings, shareholder requirements and so on.
- No
limit on number of members
- Allows foreign
and corporate members
- Pass-through tax
entity - can allocate profit and loss any way they wish to members
on individual tax returns
- No business tax
- Limited liability
for all
- Owners can participate
in management
- LLCs can hire
a management group that includes members, nonmembers or a combination
- Fixed 30 year term
- Requires an operating
agreement
- Each member pays
self-employment tax
- Some
states require at least two members
- Interests may not
be freely transferable
- difficult to raise
capital
- No automatic termination
for death or withdrawal
- S corporation may
be more tax friendly
- Can pay salary
and fringe benefits
If you plan to take
the business public you may want to form it as an "S" corp
or convert it.LLCs have only existed as a form of business since 1996,
so there is little legal precedent to help owners predict how court
decisions or legal disputes may affect the business.
More information:
legalzoom.com
Corporate
Organizational Structure
A corporation must
have a Board of Directors to represent stockholder interests, hire
the
President and oversee the direction and guide major business decisions.
The President manages and operates the day-to-day business decisions.
The Articles of Incorporation and the Bylaws establish the lines of
authority
between these three authorities: Owners, Board and Management. (see
Startup Forms, Paperwork and Regulations)
Stockholders
Board of Directors
(Chair, CFO, Secretary)
CEO/President
Top Management
Middle Management
Supervisory Management
Staff
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Advantages of a Corporation
- No personal liability
for stockholders (owners)
- Can attract capital
easier and in large amounts
- Has a "perpetual" life
- Easy to transfer
ownership/transfer may not affect operations
- Attract skilled
people
- Easier to raise
capital
Disadvantages
of a Corporation
- Cost and time to
incorporate/paperwork, legalities to operate
- Double taxation
(corporate profits, dividends/salaries)
- Potential loss
of control by founder
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