If you’re thinking of starting a business, you’ve probably wonder whether you could be personally responsible for business debts, how to manage having business partners, and what to do about future plans to expand, sell, or transfer your company. The answers to these questions depend on the type of business you choose to form. This article will cover the four most common business types used today, including some advantages and disadvantages of each. If you’d like more information about these or other business types, you should consult an attorney licensed in your state.
The most basic business type is a sole proprietorship, which is a person doing business as him or herself. The person can do business under their own name, or can register an assumed name (also known as a d/b/a) to do business under a different name.
The biggest advantage to a sole proprietorship is that there is little or no setup or maintenance work required. If you’re using your own name, in most states you can just start doing business. If you’re using an alternate name, the process to register that name with your state’s Secretary of State office is generally quick and affordable. Be mindful, however, that no matter what business type you’re operating under, you must comply with your state’s sales and use tax laws, which may require a business license or other registration.
The biggest disadvantage to a sole proprietorship is that the owner is personally responsible for the business’s debts. So, if the business owes on a contract, you owe on the contract. If someone gets hurt on the business’s jobsite, your personal assets could be on the line. Another common problem is that a sole proprietorship cannot be easily sold or transferred. Because the owner is the business, the business cannot be transferred to a new owner. Instead, the assets must be sold and the buyer must either start a new business or incorporate those assets into the buyer’s existing business.
A general partnership is a sole proprietorship with more than one owner. Here, as above, there is little or no barrier between a partner’s personal assets and the debts or liabilities of the company. Additionally, most general partnerships will end if one partner dies or leaves the company, making them difficult to pass on as family businesses. Because general partnerships have more than one owner, it is highly recommended that the owners have a partnership agreement that lays out the rights and responsibilities of the partners. A good partnership agreement can reduce conflict, streamline business operations, and ease the transition if one partner dies or leaves the business.
Smaller businesses that want to limit the business owners’ liability may choose to do become a Limited Liability Company, also known as an LLC. In that case, the owners would register the new company with their state’s Secretary of State office and obtain a new Tax ID (called an EIN) for the company. Once created, the LLC is a new entity that exists separately from its owners. It will have its own assets, debts, bank accounts, finances, and contracts. Its owners (called “members”) own Membership Interests in the company, which can be split as percentages (e.g., Jane owns 40% and Chuck owns 60%) or Membership Units (Jane owns 400 Units and Chuck owns 600). Depending on the way the LLC is set up, the members may be able to vote on direct operations of the business, or may be limited to voting to appoint those that direct the daily operations. An LLC Operating Agreement will allow the members to decide who decisions will be made, what rights the members have within the company, and what (if any) restrictions there will be on the sale or transfer of membership interests. LLCs can operate as long as there is one or more members that own interests in the company.
The biggest advantage to an LLC is the limited liability protection that it provides. While not an absolute shield, members will generally not be personally liable for company debts. Note that this does not mean that you do not need insurance for the company; it means only that for those claims that insurance does not cover, the company will normally be liable, rather than the owners. Another significant advantage to an LLC is the ease of transferring ownership. Unlike a sole proprietorship or general partnership, an LLC can last forever because it exists separately from its owners. Ownership interests can be sold, gifted, or transferred through a member’s will. If the member’s wish to limit any of those transfers, they have the option to do so through the company’s Operating Agreement. A third advantage to an LLC is that it’s internal record keeping and maintenance requirements are generally fewer, simpler, and more flexible than those of a corporation, making the LLC a great choice for a small company.
The disadvantages to an LLC are that there are more setup expenses and efforts required to create the company than a partnership or sole proprietorship. Additionally, most states require at least one annual state filing to maintain the LLC in good standing, though this filing is usually simple and requires no or only a very small filing fee. Finally, LLC interests cannot be publicly traded, so if you’re planning on taking your company to the stock market, this will not be a good choice for you.
Corporations, like LLCs, offer their owners (called “shareholders”) protection from business debts or liabilities. Corporations, however, are a more formal type of business entity designed for larger companies or companies where the owners may not all work closely together. In order to ensure that all shareholders are treated fairly and have access to information about the company, most states have extensive record keeping requirements for corporations. Like an LLC, a corporation can exist forever and its shares can be sold, gifted, and transferred unless limited by an agreement of the shareholders.
Advantages to corporations can include their formal nature, which can be helpful to investors; the liability shield it creates for shareholders; and the fact that their shares can be publicly traded. Corporate shares can be sold, transferred, or gifted freely, unless the shareholders agree otherwise. Disadvantages include limitations on the number and type of shareholders the company can have if it wants to have flow-through (S-Corp) taxation, and the fact that the extra record keeping requirements can be a burden on small, closely-held companies.
Choosing the right business structure can determine how your company is run, what liabilities you might be exposed to, and what your responsibilities are a business owner. Laws vary from state to state, so if you have questions about which type is right for you, you should check with a business attorney licensed in your state.
This article provides general information on business matters and should not be relied upon as legal advice. A qualified attorney must analyze all relevant facts and apply the applicable law to any matter before legal advice can be given. If you would like more information regarding business law or other legal matters, please contact Zlimen & McGuiness, PLLC at 651-331-6500 or email@example.com.