So you want to start a company. Which business structure are you going to choose?
There are quite a few options available, but four of the main business entity types will be discussed in this post: sole proprietorship, partnership, limited liability company and corporation. While there are specific tax implications and filing requirements associated with each of these business structures, I will be focusing on the general characteristics of each entity type.
Sole Proprietorship
A sole proprietorship consists of only “one” individual. (Note: a husband and wife can constitute a sole proprietorship.) Unlike a limited liability company (LLC) or corporation, you do not have to register your business with the state to set up a sole proprietorship, but you may have to comply with local registration, business license or permit laws.
A sole proprietorship is created as soon as you go into business, and business continues to exist as long as the business owner is alive. Once the owner dies, the sole proprietorship ceases to exist.
There is no separate legal entity/legal person apart from its owner. As such, the sole proprietor is personally liable for all the debts and actions of the company.
Partnership
A partnership is a business with more than one owner that has not registered with the state to set up a corporation or an LLC. There are two types of partnerships: general partnerships and limited partnerships. I discuss the general partnership, in which every partner is actively involved in managing the business and is therefore personally liable for business debts.
Agreeing to go into business with another person will create a partnership. While a written partnership agreement amongst the partners is not legally required, it is advisable. Otherwise, the default rules of your state’s partnership laws will apply.
Partners are personally liable for all the debts and actions of the company. In addition, any individual partner can usually bind the whole business to a contract or other business deal. Unless a third party has reason to know of any limits the partners have placed on each others’ authority in their partnership agreement, any partner can bind the others to a transaction.
When one partner wants to leave the company, the partnership generally dissolves.
Corporation
A corporation is an independent legal entity owned by its owners (called “shareholders”) through stock ownership. Shareholders are not responsible for the management of a corporation; instead, a corporation is managed by a board of directors who oversee the major business decisions of the company and officers who manage the day-to-day affairs.
Corporations are formed by filing “articles of incorporation” with the state secretary prior to conducting business. Corporate bylaws (the operating rules of a corporation) must also be created and amended as necessary over time.
One of the primary advantages of incorporating is that generally, the shareholders’ personal assets are protected from creditors of the corporation. Unlike a sole proprietorship or partnership, a corporation is treated as a separate legal entity with detached accountability. In order to retain the corporation’s status as a separate entity, certain formalities must be observed (i.e., the holding of annual shareholders’ and directors’ meetings, the keeping of minutes of major decisions, and the separation of personal funds from corporate funds). If corporate formalities are not kept up, a court may permit the “piercing of the corporate veil,” and hold a corporation’s shareholders personally liable for business debts.
Unlike a sole proprietorship or partnership, a corporation does not expire upon the death of its shareholders, directors or officers. A corporation continues until it is dissolved.
Limited Liability Company
An LLC is a hybrid business entity type and has the benefits of both a partnership and a corporation. The liability of the owners (called “members”) of an LLC for debts and obligations is limited to their financial investment, like the shareholders of a corporation. However, members of an LLC have the right to participate in the management of the LLC, unless the LLC is to be managed by managers.
An LLC is formed by filing “articles of organization” with the state secretary prior to conducting business. The LLC members must enter into a verbal or written operating agreement. A formal, written agreement is advisable for similar reasons mentioned above for partnerships and corporations.
In general, all the members are protected from personal liability for business decisions or actions of the LLC. That said, members are not necessarily shielded from wrongful acts, including those of their employees. Although LLCs are not required to observe the same formalities that corporations do, a court may permit “piercing of the corporate veil,” and hold an LLC’s members personally liable for business debts.
When a member leaves an LLC, the business is dissolved. However, the remaining members can decide if they want to start a new LLC or part ways.
For more information on which business entity to choose when forming a company, contact an attorney specializing in business entity formation for a consultation.
Lizbeth Hasse
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