There are various possible business structures you can choose through which to run your business.
Your choice of business structure will impact on three major areas:
- Personal liability;
- Taxation; and
- Making deals with investors. This is very important if you lack money for your business. Offering people a share in your
business if they lend the business money will make it easier to get money than if you were just asking for loans.
So let’s deal with the different types of business structures:
SOLE PROPRIETORSHIP
A sole proprietorship is easy to set up. There is very little red tape, and you can open or close your business at any time. You have total control over your business’s operation, and the profits you earn are filed on your personal tax return as schedule C income. The downside to sole proprietorship is that you are personally and completely liable for every expense and liability having to do with your business. One legal judgment against you could wipe out everything you own.
This is most often used when a person goes into the business alone with the understanding that he/she will make all the profits and be responsible for any losses that are incurred in the business.
PARTNERSHIPS
Partnerships range from general partnerships to the limited liability partnerships.
The General Partnership
In the general partnership all partners share in both the
management of the business and the financial gains and losses.
All the partners are responsible for the liabilities of the business. When decisions need to be made relating to business operations, they are decided by a majority vote. If the partners own unequal percentages of the business, their votes weigh in proportion to the percentage of the partnership they each own. If there are only two partners who own equal shares of the business, they will need unanimous consent.
Partnerships are the only business entities that can be formed by two people by oral agreement, and in many cases this is just how they are formed. Regardless of the fact that it is legal to form a partnership by oral agreement, it is advisable to have a written partnership agreement. I recommend that you use an attorney for this purpose even though there is a sample agreement in these
materials. Look at the agreement and see whether it fits your
arrangement. A partnership is formed automatically when two or more people act as co-owners of a business for profit.
Limited Partnership
The limited partnership is made up of two different kinds of
partners. The general partners manage the business operations and the limited partners invest capital and share in the profits. Limited partners generally do not share in the management of operations. Limited partners are only responsible for the debts of the company to the extent of their investment. They enjoy liability protection, the same as shareholders of a corporation would.
Some states allow a limited partnership to be formed by oral agreement, however, most require a filing with the State to establish the partnership. Even if your state allows an oral agreement, it is wise to establish one in writing to assure that limited partners are, in fact, protected from liability. Limited partnerships have become less popular due to the rise of the limited liability company.
Partnership Agreements
The partnership agreement should address how decisions are to be made, how to handle a death or buyout, and how to address disputes. There are numerous points that the agreement should cover.
- How the ownership interest will be shared – If ownership is not shared equally, it is especially important to have this addressed in writing.
- How decisions will be made – Voting rights should be
addressed here.
- How to determine the purchase price in the event one partner dies or wishes to retire – Having a neutral third party such as a banker or accountant find an appraiser for the business is
one solution.
- How money will be paid in the event that a partner withdraws – Having to pay one lump sum on the spot could create problems with your cash flow. Spreading out the payment over a period of several years could alleviate these kinds of problems.
Partners may choose to have life insurance policies over each others lives and the proceeds used to purchase the deceased partner’s share.
Partnership Government – The rules of the partnership
Unless you set up your own rules of government for your partnership, it will automatically be subject to the rules that your state has set up for the government of partnerships. While state rules are always made in an effort to be fair to all partners, state laws may not be appropriate for your partnership. If you do set up your own rules of governance, they take precedent over any laws the state may already have in place.
LIMITED LIABILITY COMPANY (LLC)
A limited liability company protects its all of its members from legal liability for the business. It allows members to sell shares to raise capital, and makes transferring ownership easier. However, there is no separate tax return for the business. The members of the corporation report profits and losses on their individual tax returns.
The Law of Agency
The agent of an entity or an agent of a person can act on behalf of the entity or person. As long as the agent is acting within his/her scope of authority, his/her actions are legally binding – even if they are extremely foolish. In a general partnership, all the members usually have the status of agents. However, partnerships can grant specific agency to specific partners in the partnership agreement.
Without written documentation, any partner can bind the entire partnership without the consent of the other partners. This is one more argument for having a written partnership agreement.
Liability of Entities
Sole proprietorship and partnerships are all or nithing business entities. In other words; all of y our profits go straight into your pocket and you are personally taxed on the profit.
The problem results in cases where the business fails and has liabilities. You are personally responsible to pay all of thiese liabilities. This could result in your losing your savings andother assets that are not even connected to the business.
Different states have different laws tha tcan protect that person's assets or part of their assets in the event of bankruptcy.
Bankruptcy laws are federal in nature and are becoming more and more slanted in favor of creditors, thereby not releasing certain debts upon bankruptcy.
Corporations, aka Companies
Corporations are not only for large businesses, but are also used by individuals and small groups of people when it is appropriate.
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