Legal 101

Business Structure

You know the basic choices: sole proprietorship, partnership or corporation. Your choice will affect your personal liability, the amount of paperwork you'll have to deal with and the taxes you'll pay.

Here's a brief overview:

Sole proprietorship. This is truly Business-R-You: You and your business are one and the same. Pros: easy to start, less paperwork than other structures, no separate business tax return, full control, and no pesky partners or shareholders. Cons: full liability for business goofs. Your personal assets are at stake should a disgruntled customer or creditors sue you.

Partnership. Share the burden and the glory with someone else. Pros: a second brain, shared risk and a second business nurturer and manager. Cons: more paperwork, including an annual information return and obtaining a federal employee ID number; each partner is personally liable for partnership debts; the possibility of disputes and disagreements; and the difficulty of finding someone who shares your vision and style and has complementary skills.

If you do go the partnership route, draft a partnership agreement spelling out the essentials: the partnership's name, the place of business, what each partner is putting into the business, how disputes will be resolved, how profits and losses will be shared, and how each can buy the other out. This is crucial.

Also get partnership insurance so one partner can buy the other out in case of death. When one partner dies, the business must either liquidate or reorganize, so future planning is key. A typical buy-sell agreement is funded by life insurance, and you must state the price the survivor will pay for the other partner's portion of the business.

Corporation. This is the most popular choice, especially if you have investors. Pros: separate legal entity which shields your personal assets in the event of a lawsuit; ease in bringing in shareholders or transferring ownership; perpetual existence, which means the corporation stays in existence until it's dissolved by directors or by operation of law. Cons: even more paperwork, including articles of incorporation, bylaws and a separate annual tax return; and double taxation, meaning the corporation as well as the salaries and dividends of the officers are taxed.

A standard incorporation is known as a "C" corporation. Variations on the corporate structure include the subchapter S corporation and the LLC, or limited liability corporation. A sub S corporation avoids double taxation by assigning profits or losses directly to the shareholders, who report them on their individual tax forms. Limitations of the sub S structure: There only one class of stock (no "preferred" vs. "common" stock or "voting" vs. "nonvoting" distinctions allowed), and you can't have more than 35 shareholders.

The LLC combines features of a corporation and a partnership. It shields against personal liability while allowing greater freedom in dividing profits and losses. Members get a membership interest (defined in the LLC membership agreement) rather than shares. Rules for an LLC are contained in state law; some states allow one-person LLCs, while others require a minimum of two partners.

The form you choose for your business depends on the business itself-what stage you're in and how many others are actively involved. Consult with a knowledgeable professional such as an attorney or accountant, weigh the pros and cons of each form of business, and then judge for yourself what will work best in your situation.


AdditionalResources

Association of Limited Liability Corporations: Click on Resources for an extensive list of links.

FreeAdvice.com: Offers free legal advice on tons of topics

Legal Guide for Starting & Running a Small Business, Volume I by Fred S. Steingold

The Small Business Legal Guide, 2nd Edition by Lynne Anne Frasier

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