SELECTING THE PROPER ORGANIZATIONAL FORM for a new business requires a keen understanding of the goals and objective of the prospective owners, as well as a thorough knowledge of all the legal and tax characteristics of each type of business entity. Moreover, it is important to look beyond the immediate needs of the initial ownership group to the changing requirements of the business as it grows and matures in the future.
There is really no established strategy or process for selecting the proper business form, and every attorney has his or her own way for approaching the analysis. It is common to use questionnaires to elicit information, and software programs are available that provide an interactive experience and the computing power to estimate the tax consequences associated with selection and use of a particular entity choice based on the financial projections provided by the principles.
TYPES OF BUSINESS ENTITIES
A SOLE PRORIETORSHIP is a form of business entity in which one individual engages in a business enterprise. A sole proprietorship can generally be operated jointly by a husband and wife. For most purposes, a sole proprietorship is seen as an extension of the individual owner and is not treated as a separate legal entity. It is the simplest way in which to conduct a business enterprise, and few formal steps are needed to begin doing business.
A CORPORATION is a distinct legal entity, both for legal and tax purposes. As such, a corporation is deemed to have an existence separate and apart from its owners, the shareholders. It has all of the powers and rights of a natural person, including the right to own property, to sue and be sued, and to enter into binding contracts.
The main advantage to conducting a business in a corporate form is that it affords the owners of the business limited liability. Thus, if the corporation is properly formed and the corporate formalities are observed, the extent of the shareholders’ liability is limited to the amount they paid for their shares in the corporation. Likewise, directors and officers are normally insulated from personal liability for the debts and obligations of the corporation.
A GENERAL PARTNERSHIP is generally defined as an association of at least two persons formed for the purpose of carrying on a business for profit as co-owners. There are no formal requirements for organizing a general partnership. While a partnership agreement is usually necessary, the agreement can be oral. Moreover, it is possible to establish the existence of a partnership by showing that the parties involved had the intent to engage in business activity for profit as co-owners.
The major advantage of operating a business venture as a partnership is the ease of formation and operation. The main disadvantage is that each partner will be subject to unlimited personal liability with respect to the obligations and liabilities of the partnership. Furthermore, each partner has the ability to unilaterally bind the partnership. For tax purposes, a partnership is considered a conduit or pass-through entity.
WHILE THE CONCEPT OF A LIMITED LIABILITY COMPANY has existed for many years, an LLC as a viable choice of entity has become popular only since 1994. An LLC is a hybrid entity, having characteristics akin to both corporations and partnerships. The LLC has been touted as combining the best of both worlds, providing for limited liability of all of its members, while retaining the flexibility of the partnership form.
Conducting a business in the form of an LLC may provide several advantages over other forms of business entities. Generally, an LLC will provide limited liability to all of the members and allow management of the company by one or more of the members or by outside managers. Additionally, it will be taxed as a partnership, and the tax items of the business will flow through to the members. However, the major disadvantage of the LLC form is that it is not available for certain professions.
While there are other entity types available, e.g., limited liability partnerships, limited partnerships, joint ventures, and business trusts, sticking with the main entities discussed above will serve one well in moving forward with a business enterprise.