Making a Smart Decision on Your Business-Entity Designation - dummies

Making a Smart Decision on Your Business-Entity Designation

By Stephen L. Nelson

If you’re in the process of setting up a business, one of your earliest decisions is the type of entity under which the business should operate. A one-owner business, for example, might consider a sole proprietorship, while a multiple-owner business can choose to operate as a general partnership. Both types of businesses, however, can also opt for incorporating or setting up a limited liability company.

To help you think clearly and opportunistically about these options, here are some factors to keep in mind:

  • Sole Proprietorships: A sole proprietorship is formed automatically in most states and in most industries when an individual decides to go into business.

    In many jurisdictions, the sole proprietor needs to acquire or apply for a business license from the state or local city government. Other than that modest hurdle, sole proprietorship requires no other special prerequisites.

  • Partnerships: A partnership is formed automatically when two or more people enter into a joint business or investment activity for the purpose of making a profit.

    As is the case with a sole proprietorship, partnerships typically need to acquire a business license from the state and perhaps the federal government. Partnership formation doesn’t necessarily require any additional paperwork or legal maneuvering.

    If you do enter into a partnership, most attorneys (probably all attorneys) will tell you that you do so at a certain amount of risk if you don’t have an attorney draw up a partnership agreement that outlines the duties, rights, and responsibilities of the partners.

    You can actually form a partnership simply by collaborating in business with someone. The law books are full of stories of people who have inadvertently created partnerships merely by collaborating on some project, sharing office space, or working together in some activity.

  • Limited Liability Entities: Most states allow several other business forms, including corporations, limited liability companies, and limited liability partnerships.

    These other business forms sometimes require considerably more work to set up, sometimes the assistance of a good attorney or accountant, and sometimes payment of at least several hundred — and possibly several thousand — dollars in legal and licensing fees.

    The unique feature of most of these other business forms, however, is that the corporation — or limited liability company or limited liability partnership —becomes a separate legal entity.

    • In many cases, this separate legal entity protects investors from creditors who have a claim on the assets of the business.

    • In comparison, in a sole proprietorship or a partnership, the sole proprietor and the partners are liable for the debts and obligations of the proprietorship or the partnership.

If you have questions about the correct business form in which to operate, talk with a good local attorney or accountant. He or she can assist you in choosing the appropriate business form and in considering both the legal and tax aspects of choosing a particular form.

As a general rule, more sophisticated business forms such as corporations, limited liability companies, or limited liability partnerships deliver significant legal and tax benefits to investors and managers. Unfortunately, these more sophisticated business forms also require considerably more legal and accounting processes and considerations.