By Bradford C. Auerbach, Esq, General Counsel, San Diego Consulting Group
When thinking about formalizing your business structure, there are several options. Each option has benefits ranging from ease of formation to protection of individual assets. Understandably, each option comes with varying costs of getting underway. A discussion with an experienced attorney will help solve your specific need, but here is a basic overview.
The easiest entity to form is the sole proprietorship. You can get underway with the least amount of filing requirements, but the downside is that the business is indistinguishable from the individual. Stated another way, you will be personally liable for any business activity. Many people that don’t want to put their personal assets at risk prefer one of the other business entities discussed below. Nonetheless, a sole proprietorship is a business you can create without formally filing with the state. Some jurisdictions however like counties or cities establish licensing and permit requirements. The county clerk in your area should have those details, as well as information on how operate under an assumed name if that is your strategy. Many people file a “doing business as” or d/b/a statement.
State and federal law essentially treat sole proprietorships as an individual operating an unincorporated business. Fundraising is usually more difficult as a sole proprietorship, so self-funding is usually the case. If you have limited assets and have confidence that you won’t encounter liability issues, a sole proprietorship is an easy process for getting your business underway.
A partnership is like a sole proprietorship, except that it has two or more owners (partners) instead of just one. In many respects, a partnership shares the same attributes of a sole proprietorship. The partners share management and profits. State and federal law present several types of partnerships; the two most common are general and limited partnerships. The latter can become unwieldy due to complex filings, unless the intention is for the new business to have many limited partners (which is to say, passive investors). Because profits and losses are ‘passed through’ to partners, the tax implications can be beneficial.
As above, if assets and liability issues are manageable then a partnership may make sense. You can later convert to a limited liability company (LLC), discussed below.
Because corporations are legal entities that exist independently from their owners, corporations are sometimes called ‘legal persons.’ Corporations, like individuals, can enter contracts, sue or be sued, hire employees, borrow money, etc. But the corporation is a business entity separate from its owners (called shareholders) and that is the main attraction. That means that shareholders can share in the corporation’s profits, but are not personally liable for its debts. Profits generally come to shareholders via dividends and stock appreciation.
Corporations can have a single or several shareholders, in which case the corporation is privately held. If there are many shareholders, the corporation is considered publicly held. Stock is issued to shareholders as a measure of their investment. It is the traditional way a growing business operates. Requirements for filing as a corporation vary by state.
Limited Liability Company (LLC)
Like corporations, the LLC can shield their owners (called members instead of shareholders) from personal liability, provided that lawsuits don't relate to members involved in negligent or intentional wrongdoing. The LLC combines elements of the three entities discussed above (sole proprietorship, partnership and corporation) to ensure that the owners of the LLC are not personally liable for their company's debts or liabilities. The LLC has a relatively low cost of formation and maintenance, making it an attractive option. Articles of Incorporation are filed with the state, and often an operating agreement is also created to describe the operation of the LLC. As mentioned above, if you are already underway as a sole proprietorship or a partnership, you can convert to an LLC.
If you need help formalizing your business structure, a discussion with our experienced legal team will help you decide which one is right for you.
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