Forming the Right Type of Business Organization
What kind of company should I form?
Is an LLC better than a S-Corp?
The answers to these questions will affect your new business for most – if not all – of its life. By the way, if you pose either of those questions on Google you’ll get over 349 million results in just over half a second.
According to the internet, choosing the right way to organize your business is easy and its even easier to file the paperwork needed to formalize the company. Because it’s vital to get it right from the start, it’s anything but simple.
A successful business starts with its organization. The type of entity you choose will dictate how the company runs, is managed, how taxes are paid, how the owners are compensated, and much more.
There are pros and cons to every type of organization. These have to be weighed in light of what the owner(s) want. Taxes, asset and liability protection, day-to-day operations, where they see the company in 5/10/20 years, exit strategies – are all factors that must be considered.
Business Type Choices
A new business can take almost any form,. Every type of corporate organization, however, must protect the owners’ personal assets. Forming a company is, in effect, creating a new person – a fictional new person.
Properly forming a company protects personal assets from business liabilities. The owner’s assets are not associated in any way with the business, They can’t be touched to settle the business’ debts and liabilities.
Forming the company the right way and doing everything needed to properly support it is vital for the business and to protect the owners.
The different entities have, as you’d expect, pros and cons. The art is to cut through those and design the ‘pros’ to the owners’ best advantage while minimizing the ‘cons.’
- Limited liability company (LLC)
- Limited liability partnership (LLP)
- Professional corporation (PC)
- Non-Profit corporation
- Sole proprietorship
Different entities have different tax considerations. To form a company under any of these corporate umbrellas, rules, regulations, and state filing requirements must be painstakingly followed.
Doing it right from the onset ensures that the owners will get all the benefits and protections they expect starting with protecting the owners from personal liability.
Doing it right means using a law firm with extensive experience guiding and advising business owners.
Hopkins Centrich is that firm. Not only are we lawyers, we are also business owners. We understand the company formation process on an intellectual and gut level.
Pros and Cons of Business Entities
Every business structure comes with pros and cons. They need to be weighed against one another while matched to the goals and needs of the owners. This shouldn’t be done lightly; it can be difficult or costly or both to change entities down the road.
Here’s a brief rundown of the pros and cons of the major forms of business ownership.
It’s probably obvious that this is the simplest form of business ownership. A sole proprietorship is owned and run by one owner solely for their own benefit. It’s simple, straightforward, there isn’t much – if any – paperwork.
There are a few advantages to operating as a sole proprietorship. All the profits are yours. There are no governance requirements so there’s not much paperwork.
You have total control of every facet of the business. About the only thing you need to start is an idea and, perhaps, a business license.
That undoubtedly sounds enticing, but there are some serious disadvantages, You are personally liable for business debts and legal liabilities. It’s hard to transfer or sell a sole proprietorship, which means it’s also difficult to leave to your heirs. There aren’t many options for tax planning or savings.
When you come down to it, a sole proprietorship is not a very effective way to organize a business. But it is simple.
There are two main forms of partnerships: general and limited. There’s a number of variations, but they all share the same pros and cons.
In a general partnership each owner invests their money, property, labor – everything - to the business. The owners are jointly liable for all business debts regardless of how much they’ve contributed to the business. Even if you only invested a minimal amount of capital, you’re still potentially responsible for all the business’s debt.
A general partnerships does not require a formal agreement. It can be based on a verbal agreement. It can be inferred based on the conduct of the owners. If you act like partners, make decisions like partners, pay bills like partner – you’re probably legally a partnership.
A real drawback to a two-person general partnership is that at the death of one partner the partnership will most likely have to be dissolved.
Limited partnerships require a formal agreement and filing with the state. It can’t be inferred. Limited partnerships do exactly what they sound like – they allow partners to limit their personal liability. They can also limit a partner’s control of the business,
Limited partnerships can get quite complicated. Records, agreements, filings with the state, and more must be fastidiously kept, allow partners to limit their own liability for business debts according to their part of ownership or investment by also limiting an individual partner’s control of the business.
Corporations go back to the East India Company in 1600. A corporation has the flexibility to allow the shareholders (owners) to attract outside capital and hire managers that don’t need not have any ownership, or claim of ownership, in the business.
Instead of becoming a full-blown corporation, there is the choice of ‘electing’ S-Corporation status. This may be particularly advantageous for closely-held businesses. S-Corporations, like partnerships and Limited Liability Companies allow for passthrough income and taxation. This eliminates one of the disadvantages of corporations.
An attractive advantage of any form of corporation is that it limits the shareholders’ liability to the amount they have invested. Profits and losses belong to the corporation. Dividends may be paid and may have tax advantages, Personal assets are never exposed to the liabilities of the company. Moreover, ownership can usually be easily transferred.
A major disadvantage is probably obvious – it’s complicated and time consuming to form a corporation. There are more regulations to be followed. Income is taxed twice (but not for an S-Corps).
A potential negative for owners thinking of forming an S-Corps is that only individuals (as opposed to other entities) can be owners. In some situations, this is a deal killer.
Limited Liability Company (LLC)
A limited liability company (LLC) can, when drafted and run properly, combine some of the best elements of partnerships and corporations. An LLC provides the owners with limited liability and income advantages of a partnership. An LLC can be – should be – run the way a corporation is.
The advantages of an LLC are compelling. The owners have limited liability for debts and loses. Profits pass through to the owners without double-taxation (each owner is taxed on his or her share of the profit at the personal level). Other entities can own LLCs.
The one major disadvantage is that because it isn’t a corporation or a limited partnership, the owners can treat it informally and run it almost like a sole proprietorship. Filings and operating agreements and more must be constantly kept up to date. The owners have to act like the owners of an LLC.
Again, these are the basic structures they can each be modified and customized to fit your personal and business needs.