There are four basic types of business entities: sole-proprietorships, partnerships, corporations, and limited liability companies, each with its own advantages and disadvantages. Consider these factors when choosing which is right for your business: Tax aspects, legal requirements and the potential for personal liability.
A sole-proprietorship is a business that is owned by a single individual (or by a husband and wife) that is not a corporation or a limited liability company. There are no legal requirements to comply with in order to create and maintain the business structure. The biggest disadvantage is that you, the business owner, are held personally liable for the debts of the business. This means that if someone sues your business and obtains a judgment against it, you will be responsible for paying it even if it exceeds the entire worth of your business. You should evaluate the potential risk of this kind of liability for your type of business to determine whether you should operate as a corporation or limited liability company instead. An attorney who practices in the area of business law can help you make this determination and can also help you understand which business structure makes the most sense for you from a tax perspective.
A partnership is a business that is owned by more than one individual (not a husband and wife) that is not a corporation or limited liability company. Nothing is required to establish the business as a partnership, it happens automatically when two or more people own a business that is not a corporation or a limited liability company. However, it is a good idea to have a written partnership agreement which spells out the commitments of the parties, including how much and what they will contribute to the business, how they will draw profits and share losses, and who will have authority and responsibility for making various decisions among other things.Â If the owners of the business do not make a written partnership agreement, state partnership law determines the obligations of the owners.
A corporation can be owned by one or more individuals. Each state's laws spell out the requirements for setting up a corporation in that state. Generally, establishing a corporation involves drafting Articles of Incorporation and Bylaws and issuing stock. The Articles of Incorporation are filed with the State and a Certificate of Incorporation is issued to the business. The main advantage of operating a business as a corporation is that the liability of the owners for the debts of the corporation is limited to their investment in the business. The biggest disadvantage is that the business must adhere to the corporate structure by conducting shareholders and directors meetings, which can be cumbersome for a small business.
Limited Liability Company (LLC)
Each state's laws spell out the requirements for operating a business as a limited liability company. The basic structure of an LLC is that it combines the management aspects of a partnership with the liability advantage of a corporation. This makes it a very desirable structure for a business. However, like a corporation, there are legal requirements that must be met in order to preserve the status of the business as an LLC. Special care is also required in establishing the LLC to make sure the desired tax status is obtained. You should consult an attorney who practices business law to establish your limited liability company. Also see Advantages and Disadvantages of LLCs.