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The Basics of Selecting a Business Entity

In today’s economic climate, many entrepreneurs are taking the opportunity to make their dreams come to life by starting their own businesses. As attorneys, one of the common questions we are asked is: “what type of business should I start?” This is a vital question for all business owners to answer. The answer depends on many different things including the business idea, the owner or owners, the location of the business, the status of funding, and much more. The best way to answer this question is to talk to an attorney who takes the time to understand your unique ideas and concerns. This post is meant to provide a brief definition of the common types of businesses along with some of their common benefits and drawbacks. Information like this can be useful to rule certain entities out and bring others into focus.

  1. Sole Proprietor

A business run by a sole proprietor is owned by one person. This is the most basic type of business structure available, but simplicity in this case also carries greater risk. On the positive side, this type of business model gives complete control to the business owner, has low costs associated with startup, and is the simplest type of business to start. However, there is no mechanism to protect an owner in this case, and liability of the owner is essentially unlimited. This type of structure can also make raising capital more difficult, as many investors will not contribute money directly to a person without some sort of business entity being formed. Additionally, the business will terminate upon the death of the owner, since there is no legal entity to survive. While a sole proprietorship may be right for some businesses, it is usually wise to select a different option.

  1. Partnership

A business run as a partnership is jointly owned by two or more persons. This is also a relatively basic form of business structure. Usually, an ownership agreement is signed by the business owners when the partnership begins. An ownership agreement should always be drafted or reviewed by an attorney before it is signed. There are some benefits to a partnership such as low startup costs, diverse voices and more ideas in company ownership, and more capital from the owners to support the new business. However, many of the downfalls are similar to a sole proprietorship. In particular, partners in a general partnership will be jointly and severally liable for debts and judgments incurred by the business, which means that all partners are liable for the entire amount on their own if the other partners are unable to pay. If a partnership is your desired business entity, it is recommended that you consult an attorney about starting a limited partnership or a limited liability partnership (LLP) which will both limit certain liabilities of the partners.

  1. Corporation

One of the more traditional types of business entity is the corporation. A corporation is an entity which is actually a “person” under the law and has powers and liabilities completely separate from its owners. In for-profit corporations, the shareholders are the owners of the entity, and in non-profit corporations, the owners are either shareholders or members. The actual management of a corporation is done by directors and officers, who usually serve at the pleasure of the shareholders. Corporations are also controlled by state law, the articles of incorporation, and bylaws. Both the articles and bylaws can be customized to fit a variety of needs. The most important benefit to corporations is limited liability. In most cases, the shareholders of a corporation are not personally liable for debts or judgments incurred by the business. Anyone seeking to sue the owners of a corporation directly must try to “pierce the corporate veil,” a legal maneuver which is usually difficult to accomplish. Other benefits of corporations include easily transferrable ownership, and an entity which survives the original owners. On the downside, corporations can sometimes be expensive to run, and there are certain bookkeeping requirements which must be followed. Further, most corporations are subject to tax at the corporate level and again at the shareholder level, meaning that owners may essentially be taxed twice. There are ways of lessening this tax impact, such as forming an “S” corporation, but an attorney should be consulted about this.

  1. Limited Liability Company

A relatively new and increasingly popular form of business is the limited liability company (LLC). In a LLC, the owners of the company are called members. An LLC is controlled by state laws, its articles of organization, and its operating agreement. These documents should be prepared or at least reviewed by an attorney. An LLC provides the benefit of limited liability to its members. Liability for members will be restricted to the amount each member contributed to the business, as an LLC is a separate entity under the law. An LLC also provides tax benefits since it is a “pass-through” entity and will not carry the double taxation for owners which comes with some corporations. LLCs are relatively easy to form and usually carry low startup costs. While there are many benefits to an LLC, tax filing may be difficult with some LLCs, and there is less caselaw dealing with LLCs which can make some disputes less predictable.

  1. Professional Entities

These types of entities are provided for under Michigan law and must be owned by licensed professionals including physicians, dentists, lawyers, certified public accountants, etc. Several of the entities listed above can form as professional entities such as professional limited liability companies (PLLC), professional corporations (PC), and professional limited liability partnerships (PLLP). While there can be differences in liability concerns, most professional entities operate much the same as non-professional entities.

The information contained here is meant to simply give readers an idea of the considerations that go into selecting a business entity. An attorney should be consulted before any final decisions are made on this topic. The attorneys at Dalton & Tomich, PLC represent many businesses including startups and small businesses to large businesses. If you have questions about selecting and forming a business entity or any other business matter, do not hesitate to contact us. We would be happy to discuss the issues as they relate to your business or business idea.

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