Erecting Your Restaurant on Solid Legal Ground
Your attorney and your accountant can help you decide how to set up your business. You have a number of options from going it alone to setting up a partnership to incorporating your business. Your decision determines how your company is taxed, how you earn an income from the business, what your obligations are if your business fails, and many other expensive decisions.
Even if you’re the only investor or are involved in a partnership, you still may want to incorporate. Without the legal protection of incorporating your business, your creditors can come after you if your business goes under. They can lay claim to your home, cars, savings, and anything else of value.
Going it alone: Sole proprietorships
A sole proprietorship is owned by one single person — in this case, you. Your attorney registers your business as a proprietorship by completing a simple form. You keep everything that you make, and you personally owe everything that you spend.
Teaming up: Partnerships
A partnership is similar to a sole proprietorship, but you’re adding extra people to the mix. You share all the profits and all the risk. No two partnerships are the same, but the partners should spell out the details, in writing, with an attorney, before they begin. Each partner should consider hiring separate counsel to make sure that the agreement is on the up and up.
Make sure that your agreement includes details about all of these concerns:
- Responsibilities and hierarchy: Figure out who’s responsible for what tasks or areas of the restaurant, who makes which decisions, and who reports to whom.
- Ownership stakes: Whether a partner is contributing money, time, or both, she’s making an investment in the company. In return for that investment, she owns part of the business. Spell out the details of your arrangement clearly, so that no one has any confusion.
- Pay rates and profits: Make sure that everyone knows how you plan to divide profits. Spell out who gets a salary and when it starts. Often, as you’re building a business, the owners take a small salary (or sometimes no salary) until the business has the money to spare. Resolve all financial issues clearly and to the satisfaction of all parties involved.
- Ultimate decision-making authority: When humans work together for any length of time (usually no more than 15 minutes), disagreements pop up. Having more decision makers can mean that making decisions becomes more complicated, so clarify how your decisions will ultimately get made. Your first line of defense is to discuss, persuade, and then compromise. But the occasion will arise that requires one person’s opinion to win the day. Write it down before you start.
- Exit options: You never want to think about this possibility before you start, but your partnership will probably end at some point. Make sure that you have an exit procedure outlined in your agreement. Usually, one partner can buy the other out, either in a lump sum payment or over time.
- Death contingencies: Definitely not a fun one to think about, but you need to consider it. Have a clear plan for handling this situation.
Almost teaming up: Limited partnerships
Limited partners are more like investors in the business than actual partners. They limit their liability legally because they aren’t involved in the operation. Say that your friend, Joe Blow, wants to invest in your restaurant. He doesn’t want to be involved in the day-to-day, but he thinks you’re a savvy businessperson and wants a piece of the action. He gives you $25,000, and he owns a corresponding percentage of your business. You draw up an agreement that specifies what he gets as a return on investment (or ROI) and when he gets it. Maybe he gets a percentage of profits paid quarterly or annually. Fast-forward five years: Things have been going well for several years, but the worst-case scenario occurs, and your business folds. Joe Blow doesn’t get his money back, but he also doesn’t incur any debts as a result of your business folding. Creditors may take your house, but Joe’s is safe and sound. That security for the investor is the beauty of limited partnerships.
As with any partnership agreement, have your attorney draw up a document with the specific language detailing the terms of your agreement with any limited partners.
Playing it safe: The corporate entity
Incorporating, or creating a corporate entity that owns your restaurant, offers you some protection if your restaurant goes under. Your attorney can set up your corporation for you, and you can be the only shareholder in your corporation and still own it completely. But incorporating also has some significant tax implications. Double taxation can be an issue: The government taxes the profits of the corporation and then passes them along to you. The government then taxes you on them again, as income. Depending on how you set up your corporation (different types of corporations exist), you may be able to lessen the tax burden. Definitely discuss your options with your attorney and accountant for the pros and cons of your specific situation.
Creating a corporate entity doesn’t remove all your responsibility in the event that your business fails. As a new restaurant owner, many lenders require you to personally guarantee loans, which means that even if your business fails, you’re still responsible for the debt. It’s kind of like cosigning a loan for your corporation. Weigh the options. Don’t plan to use your corporation as a shield if you have less than honorable intentions. If you run out on your rent or creditors, you develop a negative reputation that will follow you throughout your career.