From the May 2002 issue of Startups

So you're getting ready to start a business. There's an important question you need to answer before you put up the "grand opening" sign--are you the owner, or will you have partners?

The owner of a business is responsible for taxes, debts, management decisions and contracts, so legal ownership is important. Since you usually have to be at least 18 to sign contracts, a lot of 'treps find they need an older person as a business partner or shareholder.

Figuring out what legal structure of ownership best suits your business can save you a lot of grief in the future. Of course, there are plusses and minuses to every structure. Most youth-owned businesses fall into one of four categories: sole proprietorship, partnership, C corporation or S corporation.

Just Me, Myself and I
The simplest, and perhaps the most common, legal structure is the sole proprietorship. That's how Kevin Hanks decided to register his company, Mass-Bikes, a bike-refurbishing business in Wilbraham, Massachusetts. A sole proprietorship means you are a one-person operation--you make all the decisions and get all the profit--with no co-owners to consider.

On the plus side, a sole proprietorship is the easiest and least expensive business to set up. There are no legal documents or agreements to file. Your profit or loss is shown on your personal income tax return, and you are known as "the boss."

On the flip side, as a sole proprietor, Hanks sometimes worries about his liability risk. If he were to be sued by a customer, Hanks could lose his business. "If a kid buys a bike, falls off and gets hurt and says it's because the wheel I put on was loose, I could be liable," says Hanks, 18. Most of his bikes are sold through online auctions or via his Web site, but Hanks is thinking about getting liability insurance soon.

Teaming Up
As Mass-Bikes grows, Hanks could decide to bring in a partner to help him with the workload. A partnership is another legal structure that, like the sole proprietorship, costs little to establish and offers a favorable income tax structure.

The downside is, Hanks and his partner will still be personally liable for any claims against the company. In fact, liability in a partnership becomes a serious concern, as every owner in the company is responsible for the actions of every other owner. So if Hanks brings in a partner--we'll call him Smith for purposes of this example--not only can a customer sue Hanks, but he or she can also sue Smith.

Incorporating
In order to protect themselves, Hanks and Smith could get insurance, or they could change the legal structure of the business by incorporating. Corporations typically have much higher formation costs than sole proprietorships or partnerships. However, since the law says a corporation is a separate legal entity from its owners, forming a corporation would reduce their personal liability.

Although there are many types of corporate structures, the C corporation and the subchapter S corporation are the most common. Business owners who plan to go public and offer shares of the company on one of the stock exchanges would need to form a C corporation. This structure allows the company to have an unlimited number of shareholders. The downside to this structure is that the IRS will tax Hanks and Smith twice--once as a corporation and again on their personal income tax returns.

To avoid double-taxation, Hanks and Smith could form an S corporation--as long as they don't intend to go public. An S corporation is a special type of corporate entity that is limited to 75 shareholders.

Once they're incorporated, if a kid gets hurt on a bike that Hanks or Smith repaired, neither one can be sued personally. The kid and his or her parents can only go after what the corporation owns, not the owners' personal assets.

Check It Out
Choosing a legal structure of ownership for your business is an important decision. You should talk through your choices with your business mentor as well as an accountant and a business attorney.

You will also need to make sure to follow your state's guidelines. Though every state has its own rules and regulations, there is a central place to start--the Small Business Administration (SBA). You can call the SBA Answer Desk at (800) 827-5722, or visit the SBA Web site. There, you'll find helpful tips on selecting a business structure as well as links to your state's Web site.

Next Step
  • Get the whole story on Kevin Hanks and his bicycle refurbishing biz on YoungBiz.com.
  • Get help choosing your business structure here.
  • Our Starting Your Own Business guide will help you with all your legal questions.