The Legal Blog

The Ps and Qs Behind Starting Your Own Business

Have you decided to start your own business or change an aspect of an existing one? Be sure you know your options, and choose wisely—the success of your enterprise could rest on your decision. Don’t worry though; sit back, relax, and read.

To some people, deciding on their business’s legal structure sounds boring, yet it’s important—doing it right could mean great rewards. Doing it wrong, well …

So, what are your options? Generally speaking, there’s sole proprietorship, partnership, corporation (S or C) and LLC. Some offer limited liability protection which means that a person’s liability for any business debt or other obligation stops with the business with which they are involved. Some offer tax advantages, while others offer organizational advantages. Here is a short outline of the characteristics of each.

Sole proprietorship: Clearly the simplest form of business structure, and, as the name implies, involves one single owner. A sole proprietorship can be organized informally and is subject to minimal regulation. Simply start selling your service or product and you’re basically in business. A sole proprietorship offers no limited liability, so it is strongly recommended that anyone acting as a sole proprietor get adequate insurance to cover any personal liability. You may find that you cannot find adequate insurance for some business activities, and if that’s the case, be careful! Choose another business structure.

General Partnership: Comprising two or more partners, each partner is generally on the hook for liabilities created by the other partner(s) during the normal course of business, and each partner is generally actively involved. The creation of a general partnership requires an agreement between the parties, which can be either oral or written. Be smart about this—get a lawyer to draft a written agreement for you. I’ve seen businesses fail not because the business was bad, but because the partners didn’t set out what each person’s expectations, obligations and duties would be.

Limited Partnership: Limited partnerships consist of one or more general partners and one or more non-general partners, known as limited partners. The rights and obligations of the general partners in a limited partnership are the same as those in a regular general partnership. On the other hand, limited partners are normally "silent"—they give money and other assets to the partnership that the general partners use in running the business. Because of their limited involvement in the partnership, the liability of the limited partners is restricted to their investment in the business. Again, have a well-thought-out written agreement—sometimes "silent" partners become very loud.

C Corporation: The legal life of a corporation begins by having articles of incorporation filed with the secretary of state. The corporation has shareholders, who elect the board of directors to oversee the running of the business. The directors then elect the officers of the corporation that run the day-to-day business of the corporation. C corporations offer limited liability. Be aware though—you’re going to be taxed twice. The business will be taxed on the corporate level, and then you as the shareholder will be taxed if you receive any money from the corporation, usually in the form of dividends or salaries.

S Corporation: Let’s assume you want a corporation but don’t want to be taxed both at the corporate level and personal level as shareholders are in a C corporation. Shareholders of a corporation may elect to have the corporation treated as a so-called S corporation, where the taxes due for the corporation are reported by the shareholders on their individual income tax returns, and the corporation itself pays no corporate tax. However, S corporations have some disadvantages: They can only have one class of stock; you can only have up to 100 shareholders and they all have to be U.S. citizens or resident aliens; you still have to keep all the corporate formalities; and it has to operate as a domestic corporation. Most people today go for the LLC over the S corporation since it basically offers the same benefits with fewer disadvantages.

Limited Liability Company (LLC): An LLC offers limited liability for all of the equity owners while allowing any owner to participate in the management of the enterprise. It’s always wise to have an operating agreement for all the members of an LLC, even though it isn’t required by law, because disputes may arise regarding issues such as business operation, who is responsible for what and how others can join or leave the business. LLCs may be member-managed, where the owners run the business, or manager-managed, where one or more managers are appointed to run the business. In California, one person may own and operate an LLC.

These are generally the options available to you. There are also limited liability partnerships, professional corporations and nonprofit corporations, yet for most, the above are what count. There are also other factors such as tax and structural considerations that could not be covered fully in this article yet are important. So seek wise counsel, and choose your entity wisely.

The information in this article is intended only as a general guide. No attorney-client relationship is created because you read the article. If you think you have a legal issue, it is best to contact an attorney.

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