A good business plan is only the first step in starting your own company. Once you have your business strategy laid-out, it's time to select the legal structure under which your business will operate.
Many different legal structures exist for businesses. These include corporations, limited liability companies (LLC), sole proprietorships, partnerships, and limited partnerships. You should select a business structure specific to the business you plan to engage in and the types of products & services you intend to offer.
CHOOSING A LEGAL STRUCTURE
- What are the potential risks & liabilities of my business?
- What costs am I willing to incur to establish & maintain the business?
- What are my potential investments?
- How will my state & the federal government tax the business?
Whether you select a sole proprietorship, partnership, limited liability company or corporation, your choice will have an impact on the way your business must operate under the law.
CORPORATION
The most complex, but personally insulated form of business is the corporation. Unlike sole proprietors, partnerships and LLCs, a corporation is an independent legal entity that can engage in financial and legal transactions, such as taking out loans, entering into contracts, filing lawsuits and even being sued without direct personal risk to its shareholders.
The primary advantage of for corporations is that it provides its shareholders with a right to participate in the profits (by dividends) without any personal liability because the company absorbs the entire liability of the organization. Shareholders do not pay income taxes on company profits, but rather on salaries, bonuses, dividends paid to them by the company.
Further separating shareholders from their company, is the liability protection a corporation offers. "Limited liability" is part of the corporate structure, which prevents shareholders from being financially responsible for debts incurred by the business. Their stocks or investment in the company are at risk, but personal assets are fully protected.
LIMITED LIABILITY COMPANIES (LLC)
Considered by many to be the best of both worlds in a business arrangement, a limited liability company combines the tax simplicity of a sole proprietorship with the legal protection of a corporation. An LLC is not a separate legal entity, so profits (or losses) from business are reported to the IRS through the owner's personal income tax return. But LLC owners are insulated from personal liability with respect to business debts, claims and lawsuits--only the assets of the company itself are at risk.
It's a good choice for a businessperson who has liability concerns, such as a store owner or small manufacturer, and wants to keep his/her personal assets completely separate from the business assets. And limited liability companies can be partnerships as well. In most states, administrative operations can be kept as informal as the owners desire; however, it's advisable to at least document important meetings or decisions for the protection of all partners.
PARTNERSHIPS
A business organization in which two or more persons carry on a business together. Partners are each fully liable for all the debts of the enterprise but they also share the profits exclusively. Many states have laws which regulate partnerships and may, for example, require some form of registration and allow partnership agreements.
One of the basic advantages of partnerships is that they tend to allow business losses to be deducted from personal income for tax purposes
General partnerships operate much as sole proprietorships do, with the partners' personal assets at risk. In limited partnerships, one partner usually manages the business, while the others are largely investors. Limited partners who are not actively involved in the operations of a business have less personal risk.
SOLE PROPRIETORSHIP
The simplest legal structure for a business is the sole proprietorship. In fact, sole proprietorships require no real set-up. Independent contractors, freelancers and commission-only sales people, for example, are all sole proprietors by default. But just about any type of small business with a single owner can operate as one, provided they don't mind the personal financial risks involved. In the eyes of the law, a sole proprietor and his/her business are one and the same.
That means that, as the business owner, you are personally responsible for all income taxes due from your company (business income is reported on your individual tax return) and for any debt incurred by your business. Your personal assets, then, are always at risk in the event of creditor collections, liens, judgments or lawsuits against your business. So, insurance is a must with a sole proprietorship and it's also wise to get legal advice on ways to safeguard your self against lawsuits.
BUSINESS LAW
