Business Entities: Which One Is Right for You and Your Business?
Many entrepreneurs are concerned about liability when starting their business. However, many of those same entrepreneurs fail to follow through on those concerns. Those concerns usually start with what type of business entity they should form. From a sole proprietorship to a corporation, entrepreneurs need to understand what each of these entities will mean for them and their business.
A sole proprietorship is the most used and inexpensive type of business entity. Most businesses start in this form because of the low cost and ease of formation. All it takes is a trip to the county clerk’s office and less than twenty bucks and you are in business. A sole proprietorship is a business that is owned and operated by one person. Typically identified as an “assumed name,” it is a way of operating a business under a different name other than the business owner. If you have a low risk business or intend to keep the business as small or part time operation, this could be a viable option.
The best thing about a sole proprietorship is the ability to have control and make decisions by yourself. You are the business and the business is you. There is no separation between the two. There are no requirements to maintain minutes or other formalities. You may file your personal tax return form 1040 and simply add a schedule C. Depending on the amount of income you make by running the business this can be simple and inexpensive option.
The same benefits of operating as a sole proprietorship also act as serious liability traps. Because there are no distinctions between the owner and the business, the owner’s personal assets are at risk along with the business’ assets. This means that if there is ever any liability that is associated with the business, it will be associated with you as well. Moreover, you will be taxed on your individual tax level, which means that if you have a lot of personal income (i.e. salary from other employment) and are in a higher income bracket, you will have to pay taxes in that higher bracket.
If you are operating a business with high risk you should not operate as a sole proprietorship. Furthermore, you have a lot of personal assets or your business acquires a lot of income a sole proprietorship should not be your entity of choice.
Ideally, if you are going to enter into a partnership, you should have a written agreement which is drafted to accurately reflect the agreement. Sadly, many perspective partners fail to focus on this issue. Sometimes the partners are friends and/or family and believe that there will never be any disagreement. However, it is my experience (as well as most business attorneys) that this belief often leads to disaster. It is always prudent to spend the time and money on a proper partnership agreement that will guide the partners through the good and bad times. A properly drawn partnership agreement will prevent disagreements from getting out of hand and will cut down (if not prevent) costly litigation costs in the end. The time and money that you are willing to spend properly drafting an agreement will well worth it.
General Partnerships are formed by either an oral or written agreement. Based on the foregoing paragraph you already know which I think is best. This entity is relatively inexpensive to form because there is no requirement to file documents on the state level. The partners will have to file an assumed name certificate with the county clerk’s office in the county which it operates business. Much like the sole proprietorship, there is generally no distinction between the partners and the business. Unless there is a written agreement to the contrary, each partner has equal management rights and equal opportunity to run the business. Partners are accountable to each other and to the business. General Partners are equally and severally liable for the debts of the business. This means that there is no distinction between the partners, their personal assets and the business. Everyone is accountable for the business.
Limited Liability Partnerships (LLP) require written agreements. LLPs are filed on the state level and require annual filings with the state. LLPs are good entities for professionals such as lawyers, accountants, and financial advisors. An LLP will limit liability for each individual partner to the extent that he/she is not personally liable. This means that if one partner commits malpractice, the other individual partners will not be held liable. Furthermore, if the partnership is sued and does not have sufficient assets, the individual partners (in most circumstances) will not be held liable. LLPs are expensive to create and require insurance before the filing can take place.
Limited Partnerships (LP) are good entities to bring in investors. Most commonly identified by laymen as “silent partnerships,” a LP will allow a partner to invest money without incurring liability for the company debts. The LP must have at least one general partner that will assume the liability for the partnership. This partner will be responsible for the day to day operations of the company and are solely responsible for the decision making. By contrast, the limited partner cannot be involved in the day to day operations of the company if it seeks to protect its limited liability. The limited partner will be entitled to profits and to be informed regarding the financial position of the LP. The LP is also required to file documents on the state level and requires a written agreement.