Imagine you are an aspiring entrepreneur with an idea for a business. You have funding prepared; you have employees hired; and you are ready to get started. But what many entrepreneurs fail to consider at the outset are the various legal aspects to consider when starting a business. How you initially structure your business can be a vital step to success in your business. This article is meant to serve as an overview of some of the options to consider when initially shaping your business.
There are a few different options when it comes to structure of a business. The question is whether the person who is starting business wants to do it alone as a sole proprietorship, whether he or she has other partners and will want to a partnership, or whether something like a limited liability company (“LLC”) or a corporation makes more sense.
Sole Proprietorship
Being a sole proprietor creates the simplest structure for a business, but it is also the riskiest. The sole proprietor has immense amount of control and flexibility, but also a much larger personal liability than some other organizational structures.
In most states, doing business as a sole proprietor requires no formal filing with the state. Because there is not a distinct business entity, all assets held by the business are commingled with the personal assets of the sole proprietor. Along with holding the profits, the sole proprietor also carries all liabilities the business may face.
Partnership
A partnership requires two or more people to go into business together. But partners in a partnership also are not required to file anything formal with the state to be recognized a business entity.
Like a sole proprietor, two partners going into business together is called a general partnership. A general partnership, like a sole proprietorship, requires the individual partners to liable for their share of income, losses, taxes, etc. While general partnerships are easy to form, most business and legal professionals would advise partners to enter a more formal entity.
Another type of partnership is called a limited partnership (“LP”) which requires one “general partner” to assume personal liability for the business while the other partner, or partners, are merely passive financiers. Another type of partnership is called a limited liability partnership (“LLP”). In this type of partnership, the level of liability imposed on the partners vary state by state. Fundamentally, in some states a partnership is like an LLC and in others it is more akin to a LP where a general partner still assumes liability.
Limited Liability Company
An LLC is the most popular of the types of organizational structures in recent years. An LLC is almost like a hybrid of the partnership structure and the corporate structure.
An entity who decides to be structured as an LLC is made up of “members” and not as partners. The main advantage to an LLC is the idea of “pass-through” taxation. Pass-through taxation prevents double taxation which means the members can avoid paying taxes twice: once on the LLC’s profits and then again on the profits the individual member receives.
To set up an LLC, an entity must file articles of organization in the state where it plans to conduct business. Additionally, most, if not all, LLC’s have what is called an “operating agreement.” An operating agreement essentially lays out the duties and responsibilities of the members. This allows for the LLC to operate efficiently as each members knows his or her role within the LLC and how profits will be distributed.
Corporation
The last type of structure a business may consider is organizing as is a corporation. A corporation has the least amount of liability associated with it. In a corporation, the liability for each individual is limited to the amount they invested in the company. Another way of explaining this is unlike in a sole proprietorship or partnership where creditors can go after the personal assets of the sole proprietor or partner, in a corporation this is not permitted.
Corporations have a traditional organizational structure such as a board of directors who oversee big decisions, officers who oversee the day-to-day operations of the company, and owners who are the shareholder of the company. Each of these different groups have certain abilities to act on behalf of the company with the board of directors having the most amount of flexibility to act. Corporations have various tax benefits as well.
Like an LLC, to create a corporation a filing of articles of incorporation in the state where the corporation plans to do business is required. In addition, similar to an LLC operating agreement, corporations have bylaws which set out the responsibilities of various people within the corporation.
What structure is best for you depends on your goals. For more autonomy, a sole proprietor might be the best option. To attract outside investment, a corporation may be best. There is a plethora of factors to consider, and every business is slightly different.
If you are thinking about starting or have any questions regarding which structure to choose the attorneys at Dalton & Tomich, PLC are experienced professionals in helping small businesses achieve their goals.
