So you have decided to go into business for yourself?
But you can’t just have an idea and open up shop… If you want to start a business the right way there is a legal process involved. This process is extremely important.
Read on and I will dive into some much needed information on choosing the legal structure of your new business venture.
What are the Different Legal Structures?
Well I’m happy you asked…
There are a few types of business structures to choose from when starting a business. They are Sole Proprietorship’s, Partnerships, Limited Liability Companies (LLC), Cooperatives, Corporations and S Corporations. For the purpose of this article I will touch only on, Sole Proprietorship’s, Partnerships, Limited Liability Companies and Corporations.
A sole proprietorship is the most widely used and simplest form of business structure. It is very easy to set up, requires minimal cost and simply refers to the owner of the business. A sole proprietorship is NOT a legal entity. If the owner is sued he/she is not protected by a separate entity. Simply put, you are your business and your business is you.
All of your personal assets are on the table in the event of a lawsuit. Starting a business under this structure also means the owner is taxed individually. This can be very attractive when using loses of the business to offset personal income taxes. You can also freely mix your business and personal assets.
Partnerships consist of a business operation between two or more individuals who share management and profits. There are several types of partnerships but the most recognized forms are the general and limited partnerships.
A General Partnership is the most basic form of partnership under common law. Each partner shares equal managerial and decision making rights regarding the business. This also means that all partners equally share liability within the partnership.
If there is a lawsuit or any outstanding debt, all partners share equal financial liability. Usually there is a partnership agreement outlining how profits are to split among the partners. If there is no agreement, all profits are equally split between the partners by default.
Partnership agreements can usually iron out any specifics of the partnership and set the boundaries for which each partner operates.
A Limited Partnership is very similar to a general partnership. The difference is a limited partnership has a number of limited partners along with the businesses general partners. Only one of the partners needs to be a general partner.
Limited partners are mostly involved in the business for financial/investing support. Meaning, limited partners have limited liability and in turn have no management or decision making authority in operating the business. Limited partners are paid a return on their investment by the general partners.
In turn, the general partners shoulder the liability for any financial loss incurred from the business operation.
Limited Liability Company
Limited Liability Companies are generally the first choice of most entrepreneurs. This type of legal structure provides a good amount of flexibility and combines the elements of both a partnership and a corporation.
I have heard many people call this type of structure a “limited liability corporation” however an LLC is not a corporation. It is a company that provides limited liability to its owners.
Some also call LLC’s a hybrid entity as it takes on characteristics of corporations, partnerships and sole proprietorship’s, depending on the size of ownership.
Many real estate investors choose to set up LLC’s for their properties. They will sometime make an LLC for each property and later sell the entire LLC to another investor.
For tax purposes an LLC is viewed as a pass through entity. If there is only one owner of an LLC income and losses are reported on the owner’s individual tax forms. This is a benefit compared to a corporation. Corporations are taxed twice, once at the corporate business level and again once profits are divided among shareholders.
The Limited Liability Company is a solid choice as it provides great flexibility. Again it is the popular choice for most business start-up ventures.
A corporation is a separate entity, separate from its employees, members and shareholders. Corporations are owned by its shareholders. However, the shareholders do not manage/run the business. Instead, they elect a board of directors then the board will hire the top management for the corporation.
Usually when we think of a corporation it is referring to very large businesses. Corporations obviously are not human beings but for legal purposes they are considered legal persons. This means they have the same rights as an individual human. They also carry the same responsibilities.
An example of this can be seen currently as the US government has charged FedEx Corporation with drug trafficking. The entire corporation is being charged in this case.
In the past corporations were created by corporate charter through the federal government. Today they can be registered with the local, state or national government and will be regulated by the laws enacted by that government.
For the initial start-up of your business you will, more than likely, not be incorporating your business. Just make sure you consult an attorney before making a decision.
For more information:
There are more options stemming from the above mentioned business structures. For additional information on these structures visit The U.S. Small Business Administration website.