How's
business? Humming along nicely? Good ... glad to
hear it. Take a seat. We're going to talk about what
you need
to start thinking about now that your business is off the ground,
so to speak.
When
you started your business, you may have done so on
a part-time basis while you continued with your full-time job.
Perhaps you're still doing double duty. If so, it's possible that
you haven't really given too much thought about the tax and
legal ramifications of the legal entity you have chosen for your
business. After all, it's hardly something to worry about
when
you're just starting out. After all, who knows whether this
thing's going to fly, right? At some point, though, once your
business begins to get off the ground, you do need to turn your
mind to such things. Now that your bird is in the air, it's
time
to give some serious thought about the entity you're using for
your business.
In
this article, we'll discuss the main forms of legal business
entities and the advantages and disadvantages of each so you
can begin thinking about which one is best suited for you, your
business and your circumstances.
Of
necessity, we're only concerned with general issues here.
Each state/province/country is different and you will need to take
the advice of your own professional adviser (lawyer or
accountant) before making a final decision that's right for you.
While
this discussion will be focusing on entities most
commonly used in the United States, most of them exist, in
some fashion or another, all around the world (although some
of the finer details will vary). For this reason, this article
is only
intended as an issue-spotter and thought-starter and should
not be used as a substitute for independent professional advice.
SOLE
PROPRIETORSHIP
The
most simple form of business entity, the sole proprietorship,
is just that ... one person who is the sole owner of the business.
If you're running your business under your own name or under a
fictitious business name that you have filed with the state (and
that fictitious name has not been filed by a partnership of which
you are a member or by your company) you are a sole proprietor.
You are required to file a fictitious business name if your
surname does not appear in the name of your business or the
name of your business suggests the existence of other owners.
Under
this form of business entity, the owner and the business
are legally inseparable. In other words, the business does
not
have an existence separate and independent from its owner.
=>
Advantages
The
advantages of a sole proprietorship are that it is simple and
inexpensive to set up (you've probably done it without even
realizing just by signing up for and promoting an affiliate program,
for example); the owner reports the business's profit/loss on his
or her personal income tax return (the business doesn't have to
file a separate tax return); the owner may offset a business loss
against other income; and the owner has total management and
control of the business.
=>
Disadantages
The
disadvantages of a sole proprietorship are that the owner has
personal, unlimited liability for the debts of the business; the
owner may find it difficult to obtain finance; community property
is at risk if the owner is married and the owner is personally
liable for the acts and omissions of agents and employees.
A
sole proprietorship may be a good choice for you if you are in
sole control of your business (i.e. you don't use agents or
employees) and where personal liability for business debts is
not a major concern. When your business starts to grow,
however, and you begin adding employees, incurring significant
debts or need to source venture capital of any substantial
amount, it may be time to consider another form of entity for
your business.
PARTNERSHIP
The
next step up from sole proprietorship is a partnership. A
partnership is a business with more than one owner that is not
incorporated and that is not a limited liability company
(corporations and LLCs are discussed below). In a partnership,
each partner shares in the management of the business and in
the liability for the acts of fellow partners.
The
internal workings of the partnership are governed by a
partnership agreement which should include issues such as the
authority of the partners, the name and purpose of the
partnership, each partner's respective contribution to the
partnership (whether in the form of money, time, expertise
or other services); payments to be made by the partnership to
the partners in the form of profits and drawings; the management
duties of the respective partners and how to handle the addition
of new partners and the withdrawal of existing partners. In
the
absence of a partnership agreement, the profits and losses of
the partnership are distributed equally amongst the partners.
If this is not the intention (for example, because of a disparity
between partners' respective contributions), the partnership
agreement should provide for this.
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Advantages
As
with a sole proprietorship, a partnership is relatively simple
and inexpensive to set up; each partner reports his or her
share of the partnership profits or losses on their personal
income tax return (again, the partnership doesn't have to file
its own tax return); a partnership offers a deeper talent pool
than does a sole proprietorship; the burden of running the
business is shared and, generally speaking, a partnership is
stronger financially than a sole proprietorship.
=>
Disadvantages
As
with a sole proprietorship, however, the partners are each
jointly and severally (i.e. together and separately) liable for
the
debts and other obligations of the business. In addition,
each
partner is liable for the acts of the other partners (within limits).
Another potential disadvantage is that because decision-making
authority is divided, disagreements may arise which may cause
friction between the partners. It would be a good idea to
provide
for a dispute resolution mechanism in the partnership
agreement to overcome deadlocks.
LIMITED
PARTNERSHIP
A
limited partnership offers a useful compromise for the business
that wants to attract capital but doesn't want to relinquish control
of the business. A limited partnership is one in which there
are
two types of partners: "general" and "limited". A general
partner
has exactly the same rights and obligations as a partner in a
traditional partnership arrangement (discussed above). A limited
partner, however, contributes financially to the business but has
minimal control over its management. So long as the limited
partner stays out of the control of the business and doesn't get
involved in any misdeeds that adversely affect the partnership
and the other partners, he or she enjoys a cap on personal
liability set at the amount of the investment or the amount
received from the partnership after it became insolvent.
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Advantages
In
addition to the advantages discussed above of a normal
partnership, a limited partnership offers the additional advantage
of being a way for the general partners to raise cash without
involving outside investors in the management of the business
and without having to deal with the intricacies of creating a
corporation and issuing stock.
=>
Disadvantages
For
the general partners, the disadvantages are the same as
for a normal partnership. In addition, it should be noted
that a limited partnership is more expensive to create than
a general partnership.
CORPORATION
A
corporation (or company) is an entity created and regulated
by state law (at least in the US). A corporation is a separate
entity from those who create it; it is, in fact, known as a legal
"person".
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