One of the most basic questions anyone thinking about starting a business should consider regardless of how small or how large that business may be at the outset is the question of what legal form their business should take. There are several forms a business can take and it is important to choose what’s best both for the business and its owners.
There are, of course, pros and cons to each available form but choosing the best form for your business can increase the ultimate profitability of your business for you as an owner while limiting your personal responsibility for the liabilities of your business. Also, if there will be more than one owner of the business, there are potential threats to the business that should be answered before business begins such as questions of what will happen if an owner dies or wants out of the business.
The cost and effort of careful planning before starting a business often seems an unnecessary expense and distraction to entrepreneurs intent on pursuing their business dream. Yet such planning is essential if the business is going to maximize profitability for its owners and survive the possible events that could otherwise bring the business to a premature death.
What follows is not intended to be an all encompassing discussion of all those pros and cons. Instead, this article is only a brief sketch of some of the principal benefits and drawbacks to each form for doing business.
Also, this discussion only addresses issues in closely held entities and does not speak to the peculiar issues of publicly traded entities or to various securities law issues that may arise even in the context of a small, closely held business entity.
Finally, it’s important to note that this discussion relies on Oregon law. While the law of other states may often be identical or similar, it is essential to determine the best form of business entity on the basis of the law applicable to your anticipated business activity.
A sole proprietorship without distinction between the business and its single owner is the easiest form of business to run, at least in the beginning. In a sole proprietorship there’s no difference between the owner and the business because the owner is the business and, at least to a large extent, the business will be the owner. In a sole proprietorship:
1. The owner is personally liable for all of the obligations and liabilities of the business; and,
2. The owner will, in addition to income taxes, pay self employment taxes on all business income.
These considerations generally make the sole proprietorship an unacceptable form of business entity to most individuals starting a new business who think about how they want to do business.
A partnership is a business relationship between 2 or more individuals. Although a written partnership agreement is not essential to create a partnership, such a written agreement defining the partners’ respective rights with respect to each other and the partnership itself is prudent.
In a partnership each partner contributes capital and other value which becomes that partner’s capital account. In a partnership:
1. No partner owns partnership property and the only interest a partner can transfer or sell is their respective share of the partnership’s profits and losses and the partner’s right to receive distributions from the partnership;
2. The partnership must maintain books and records which are available for inspection by the partners and their agents such as attorneys;
3. Each partner has fiduciary duties of loyalty and of care to the partnership and to their partners;
4. A written partnership agreement can provide for different classes or groups of partners with different powers and duties including different voting rights;
5. All partners are jointly and severally liable for all obligations of the partnership incurred while they are partners; and,
6. Income earned by the partnership is ascribed to each partner in proportion to their partnership interest for tax purposes as self employment income whether it is actually received by the partner or not.
While partners can significantly limit the personal liability of limited partners in a limited partnership, a limited partnership must have a general partner who is personally liable for the partnership’s obligations.
Because a partnership is largely defined by the agreement of the partners, a written partnership agreement is essential at the outset of the business.
Though well suited for some business ventures, a partnership is often not the best choice of business entity.
Corporations are owned by one or more shareholders who elect one or more directors to oversee management of the corporation’s activities. Corporations can consist of a single shareholder who is also the sole director and president or can consist of many shareholders who elect directors who may have no relationship with the corporation except for their role as directors supervising the corporation’s officers who in turn may have limited, if any, equity interests in the corporation.