Business Organization & Transactions Newsletter
Formation and Business Planning
One of the decisions business owners must make is choosing the ownership structure that the business will have. Owners must consider the amount of liability they want to assume, tax implications for the business, how the business will be financed, control of the business, how long the business will exist and how business interests can be transferred. Some of these considerations may be more important than others depending upon the owner’s goals.
Business entities vary in their organization, liability and tax consequences, and in other ways depending on the state in which they are located. Here is an overview of business entities:
Sole proprietorship: A sole proprietorship is run by an individual owner, whose activities are basically inseparable from the activities of the sole proprietorship. The owner of a sole proprietorship faces unlimited personal liability for business losses. Income from the business is generally taxed as personal income to the owner. Some attractive features of the sole proprietorship are its relative simplicity in structure, formation and management. The business is funded through personal assets of the owner and it can continue to exist during the owner’s lifetime.
Corporation: A corporation provides limited liability to its members, so that they will not be personally liable for any of the corporation’s debts. But to obtain financing, members may be required to sign personal guarantees, making them personally liable for the corporation’s losses. A board of directors runs a corporation, although some corporations may be directly controlled by the shareholders. S-corporations and C-corporations are distinguished by their tax treatment. Non-profit organizations can also incorporate to protect management from liability.
Some advantages of the corporation are its perpetual existence and ease in transferring assets. Some disadvantages of corporations can be double taxation through corporate tax on the corporation’s earnings and an individual tax on shareholders’ earnings, as well as the cost and expenses of setting up and maintaining a formal corporate structure.
Partnership: Partnerships can be either general partnerships or limited partnerships. General partners are jointly and severally liable for the debts of the partnership, and limited partners are liable up to the amount of their capital contribution. Partners can dictate the terms of the partnership in a partnership agreement. General partners control the partnership; limited partners must not exercise control if they want to maintain limited liability status. Financing for the partnership comes from contributions of the partners or third parties.
Advantages of a partnership include limited formalities and the ability to dictate terms of the partnership. A disadvantage of a partnership is that it ends when the partners go their separate ways, and this can be at an inopportune time for the business.
Limited Liability Company (LLC): A limited liability company’s primary advantage is conveyed in its name: limited personal liability for the company’s obligations. Either a member or a third party will manage the LLC under the terms of an operating agreement. Members contribute to the financing of the LLC and may have security interests that are subject to state and federal laws. LLCs may be taxed similarly to limited partnerships but must meet certain requirements in organization. LLCs also have other tax advantages for members. Similar to corporations, LLCs must file documents, called articles of organization, with the secretary of state.
Franchise/Distributorship: Franchises and distributorships are another type of business ownership that entrepreneurs frequently pursue. Basically, a franchise is an agreement between a franchisor and an entrepreneur to license a trade name or trademark so that the entrepreneur can sell products (sometimes referred to as a distributorship) or services bearing the name or mark.
Business owners may also consider other entities such as cooperatives and associations, depending on the goals of the business. An experienced business attorney can provide valuable assistance when selecting a business entity.
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