New Business

Is a corporation the right entity for my new business?

Perhaps the most important decision you'll make when starting your business is what type of business entity you will choose. The most common business entities are a sole proprietorship, partnership, limited liability company, and corporation. In the last part of this series, we will discuss the pros and cons of the corporation.

Corporation

A corporation is a distinct legal entity, both for legal and tax purposes. It is deemed to have an existence separate and apart from its owners, the shareholders. A corporation 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.

Although owned by its shareholders, a corporation is controlled by the board of directors, which is elected by the shareholders. The shareholders' participation in the management of the corporation is essentially limited to electing the directors and voting on certain major corporate actions. However, shareholders may elect themselves to the board of directors and may still participate in management.

While the directors control and are permitted to manage the corporation, the board of directors generally appoints officers to manage the corporation's day-to-day operations. In smaller corporations, such as S corporations, the shareholders are often also the directors and officers.

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Pros

  • The corporation enjoys a separate legal existence with its own rights, privileges. and liabilities apart from the shareholders.
  • The shareholders' liability is limited to the amount they paid for their shares in the corporation.
  • Directors and officers are normally insulated from personal liability for the debts and obligations of the corporation.
  • Additional investment are generally easier to obtain, i.e., corporations may obtain investments from third party sources in exchange for the sale of stock.

Cons

  • Corporate formalities must be observed such as annual shareholder meetings and regular director meetings, among other formalities. 
  • Increased cost to form and operate a corporation, i.e., file articles, draft bylaws, shareholder agreements, file annual reports, etc.
  • Potentially decreased personal control of the business because of the separate roles of shareholders, directors, and officers.
  • The profits and losses of a C corporation are subject to double taxation: once at the corporate level when earned; and then at the shareholder level when distributed (does not apply to S corporations).

S Corporation

For legal purposes, an S corporation is no different than any other corporation. However, an S Corporation enjoys certain tax benefits. For instance, an S corporation is considered a pass-through entity, similar to partnerships. In this manner, the S corporation escapes the double taxation on dividend distributions of a C corporation, and the shareholders are allowed to offset losses sustained by the S corporation against their other income. 

Not all corporations may become S corporations.  The corporation must have no more than 100 shareholders, must have only one class of stock, and shareholders cannot be a corporation, LLC, or partnership, among other restrictions.

Summary

A corporation is a good choice for business owners that are seeking to minimize their personal liability, do not mind the increased formalities and operating costs of a corporation, and are seeking outside investors. While the double taxation of income of a C corporations is a downside, most new corporations can quality as an S corporation to avoid this. 

If you have any questions regarding your new business, or would like assistance forming your corporation, schedule a free consultation with J.Cutler Law.

 

Is an LLC the right entity for my new business?

Perhaps the most important decision you'll make when starting your business is what type of business entity you will choose. The most common business entities are a sole proprietorship, partnership, limited liability company, and corporation. The most popular business entity for limiting ownership liability is the limited liability company.

Limited Liability Company

A limited liability company (LLC) may be owned by one or more "persons" (individuals or corporations) known as "members" of the LLC. An LLC may be managed by the members or by an outside manager. 

An LLC is a hybrid entity, having characteristics of both a corporation and a partnership. Essentially, the LLC combines the best of both worlds -- providing for limited liability of all of its members, while retaining the flexibility of the partnership form.

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Pros

  • Not required to hold annual meetings or comply with the many operational restrictions imposed upon corporations.
  • Provides limited liability to all of the members. 
  • Unlike a limited partnership, a member of an LLC will not lose the protection of limited liability by participating in the management of the LLC.
  • For tax purposes income is only taxed once, i.e., earnings of the LLC are treated as the earnings of its members and thus no separate tax is imposed on the LLC.

Cons

  • Must file a certificate of organization with the state.
  • Must enter into an operating agreement.
  • Must file an annual renewal with the state.

Summary

An LLC is the preferred business entity for those wanting to limit their personal liability while also maintaining control of the management of their business. Although an LLC requires more formalities than a sole proprietorship or general partnership, it will likely be worth it if your business runs any risk of personal liability. 

If you have any questions regarding your new business, or would like assistance forming your LLC, schedule a free consultation with J.Cutler Law.

 

Is a partnership the right entity for my new business?

Perhaps the most important decision you'll make when starting your business is what type of business entity you will choose. The most common business entities are a sole proprietorship, partnership, limited liability company, and corporation. In the second part of this series, we will discuss the pros and cons of the partnership.

Partnership

A partnership is formed when two people agree to work together and share the profits of their business. In its simplest form it is two teenagers splitting the profits from their lawn mowing business. The most common partnerships usually involve friends or relatives coming together as co-owners of a for-profit business.

There are generally two types of partnerships, a general partnership and a limited partnership.

General Partnership

A general partnership is one in which there are no limited partners, i.e., There are no partners who are investors only and do not participate in the management of the business.

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Pros

  • General partnerships are permitted to engage in any type of business or profession.
  • There are no formal requirement for organizing a general partnership.
  • Although a partnership agreement is usually necessary, the agreement can be oral.
  • For tax purposes income is only taxed once, the partners are required to report the profits and losses on their individual income tax returns.

Cons

  • Each partner will be subject to unlimited personal liability with respect to the obligations and liabilities of the partnership.
  • Each partner has the ability to unilaterally bind the partnership, unless acting outside the scope of authority.

Limited Partnership

A limited partnership is a partnership where there are one or more general partners and one or more limited partners, i.e., at least one partner is an investor only.

Pros

  • Attractive option for raising capital.
  • Limited partners, i.e., investors, have liability limited to the amount of their capital contributions.
  • General partners maintain management control of the business.
  • For tax purposes income is only taxed once, the partners are required to report the profits and losses on their individual income tax returns.

Cons

  • Requires more formalities than a general partnership, such as filing a certificate of limited partnership with the state and the creation of a partnership agreement.
  • General partners remain personally liable for all partnership debts, obligations, and liabilities.
  • Certain formalities must be observed in order for limited partners to enjoy a shield from personal liability.

Summary

Choosing a partnership for your new business is generally appropriate in situations where your business is likely to remain small and the potential exposure to liability is minimal. If this is the case and you are seeking to raise capital without relinquishing control of your business, then a limited partnership might be a good choice for you. However, if you would like to avoid any risk of personal liability, a limited liability company or corporation may be a better choice.

If you have any questions regarding your new business, or would like to determine if a partnership is right for you, schedule a free consultation with J.Cutler Law.

Is a sole proprietorship the right entity for my new business?

Perhaps the most important decision you'll make when starting your business is what type of business entity you will choose. The most common business entities are a sole proprietorship, partnership, limited liability company, and corporation. The most basic entity is the sole proprietorship.

Sole Proprietorship

A sole proprietorship is when one individual operates a business. For most purposes, a sole proprietorship is seen as an extension of the individual owner and is not treated as a separate legal entity. In its simplest form it is a child at a lemonade stand. Most often it is seen with small, family owned businesses. 

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Pros

  • Is the easiest and simplest form in which to conduct a business
  • There is no paperwork needed to create a sole proprietorship.
  • Very few formal steps are needed to begin doing business.
  • For income tax purposes, income is only taxed once, i.e., the profits and losses of the business activity are reported on the owner's individual income tax return.

Cons

  • The owner is personally liable for of the debts of the business and all of the owner's personal assets are at risk.
  • The source of capital available to the business is limited to the owner and the owner's ability to borrow funds. 
  • The owner cannot seek investment since any investment would mean that the business is no longer a sole proprietorship.

Summary

Choosing a sole proprietorship is generally appropriate only when the following factors are met:

  1. The business is likely to remain small. 
  2. The type of business does not present a high risk of liability exposure. 
  3. The owner does not intend to seek outside investment. 
  4. The owner wishes to avoid the cost of incorporating and the administrative burden of adhering to corporate formalities.

If you have any questions regarding your new business, or would like to determine if a sole proprietorship is right for you, schedule a free consultation with J.Cutler Law.