From a mom-and-pop operation to a billion-dollar venture, at the beginning of every new business the important question must be answered: what type of legal entity would be the best vehicle for meeting the goals of this particular business?
The new business owner should allow the time and expense necessary to prepare a solid business plan, giving careful thought to short- and long-term goals, as well as immediate and future operational plans. Financial information should be pulled together for the individuals contributing to the business, as well as financial projections for the new business, including anticipated cash and credit needs. Thought should also be given to management structure, compensation, business duration, insurance and assets.
The business plan should be the springboard for the decision of what type of business entity to use. The two main considerations in choice of entity are usually tax consequences and personal liability of owners for business debt. These issues can have vastly different results depending on the type of business entity chosen.
Other considerations can be important to the entity choice as well, like ease of administration. Some legal entities are more highly regulated than others, requiring more detailed recordkeeping and more involvement by professional advisors like tax accountants.
The available choices of organizational forms are controlled in most part by state law. In California, for example, some of the more common business-entity choices include:
- Sole proprietorship: This is the simplest way to carry on a business, used when an individual or married couple operates an enterprise without much formal legal structure. The cash and assets are put up by the owner, who is responsible personally for the business liabilities and taxes.
- General partnership: A business structure formed by two or more persons who agree to co-own the enterprise and equally divide profits and losses. Each partner will be personally liable for taxes and business liabilities.
- Corporation: A legal entity in its own right separate from its incorporators, a corporation operates in most ways like a person with the ability to conduct business. Corporations are usually owned by shareholders who buy stock in the corporation and elect a board of directors to run the business. Shareholders and directors are usually not personally liable for corporate debts and liabilities.
- Limited liability company: Usually called an LLC, this entity is a hybrid of the corporation and the partnership. LLCs are not taxed as standalone enterprises; rather the individual members of the LLC are taxed like partners. Members are usually not personally responsible for LLC business liability.
This has been only a brief look at business-formation issues. A potential business owner should consult an experienced, knowledgeable business attorney as early in the process as possible to learn about the various choices of business entities available, and the pros and cons considering the particular venture. The tax and liability issues can be complicated, and competent legal guidance can make all the difference.
