When establishing a new business venture or enterprise, choosing the right type of organization is the first necessary and crucial step to start on the road to success. Over the years, we have counseled clients in a wide variety of industries and businesses and have worked with all types of business structures. For example, these have included Limited Partnerships and Limited Liability Companies (for numerous entertainment production ventures) to structuring more complicated holding companies with subsidiary corporations to spread risk and potential liability. Below, you can click on each of the major type of business entities to get a clearer understanding of their purpose, how they work and their advantages and disadvantages.
Sole Proprietorships [+]
Sole proprietorships are owned by one person who is unlimited liable for debts of the company. Sole proprietorships are not separate entities from the owner in terms of taxes, liability and management. They are generally often at a disadvantage in raising capital because outsiders are generally unwilling to risk money on the life of an individual. Similarly, it is often difficult to sell a sole proprietorship, and diversification is also difficult because of the size of the company.
Partnerships, General and Limited [+]
Partnerships are formed when two or more partners join together and operate a business for profit. Partnership law in the United States is generally subject to the Uniform Partnership Act which has been adopted in 49 states, while 26 states have adopted the Revised Uniform Partnership Act. The UPA and the RUPA operate when nothing is said in the partnership agreement regarding a point of law. Partners have great freedom to mange the partnership and divide profits in just about any way that they want.
There are two types of partnerships: general and limited. In a general partnership, all partners are unlimitedly liable, while in a limited partnership only the general partners are liable for partnership debts. Relative to sole proprietorships, partnerships have a number of advantages raising capital. Partnerships are more complicated to manage and disputes among partners are sources of litigation. Profits of both partnerships and sole proprietorships are taxed as ordinary income to the partners or owners. Partners owe a fiduciary duty to each other, which means that they must put the interests of the partners and partnership above their own.
Limited partnerships must be registered with the state in order to qualify for limited liability for the limited partners. Limited Partners must refrain from management activity to qualify for limited liability. The line between what limited partners can do and not do to qualify for limited liability is articulated in the Revised Limited Partnership Act. Limited partnerships enjoy favorable tax status. Also, transferability of ownership is much easier than for general partnerships.
Corporations (S and C Corps.) [+]
Corporations are considered persons in law. They can sue and be sued, must pay taxes, and have potentially infinite duration. Corporations are managed by a Board of Directors who then appoint chief corporate officers. Shareholders of a corporation are its owners and benefit from limited liability. Ownership of a corporation is transferable through the sale of corporate shares. Corporations are taxed on their income and, if dividends are declared, shareholders are taxed on dividend distributions. Both directors and officers are agents of the corporation and as such owe fiduciary duties to the corporation. In general, corporations provide shareholder owners with limited liability, even if mistakes are made in complying with incorporation statutes. Shareholders can lose their limited liability if they abuse the corporate form if they fail to comply with corporate formalities, deal with creditors as individuals, commingle corporate and personal funds, or are deliberately undercapitalized.
Corporations in general are more costly to organize, subject to more government oversight, have significant public reporting requirements and overall have generally higher taxes due to double taxation. S Corporations, are generally smaller than C Corporations. S Corporations are taxed as if they are partnerships, but there are restrictions that make C Corporation the only alternative for corporations with more than 75 shareholders. They however, suffer from the double taxation penalty whereby income is tax both at the corporate level and the individual level.
Closely Held Corporations [+]
Closely held corporations share a lot of characteristics with partnerships. The largest shareholders are generally also on the board of directors and are chief corporate officers. Closely held corporations are governed by bylaws and shareholder agreements that resemble partnerships. Limits are placed on transferability of ownership stocks, protections are in place to protect minority interests and there are provisions for resolving disputes.
Limited Liability Companies (LLCs) and Limited Liability Partnerships (LLPs) [+]
Limited Liability Companies and Limited Liability Partnerships straddle the advantages of limited liability of corporations and the tax advantages of partnerships. They are in essence a hybrid, which have been created as a fiction by law. In LLCs not only do the members of the LLC become protected from liability but so do the Managing Members, which is an advantage over a General Partner in a limited partnership. Like S Corporations, LLCs. Offer the joint advantages of corporate limited liability and the favorable tax treatment of a partnership with earnings flowing through to individual LLC owners’ personal income for tax purposes. LLCs differ from S Corporations in a number of advantageous ways. They are permitted to have multiple classes of stock, can have any number of stockholder members, and are not limited in the classes of owners, so they can issue stock that will be owned by corporations and partnerships. LLPs on the other hand, are often selected by professionals while still complying with ethical requirements of state licensing board. An LLP generally provides partners with protection against claims resulting from the malpractice of other members or employees of the partnership. In addition, however, partners still generally remain personally liable for general debts of the partnership such as those incurred for rents, repairs, bank loans, etc.
Joint Ventures [+]
Joint ventures are like partnerships of two companies or individuals that are organized to accomplish a task but do not generally have an indefinite life. Joint venturers are jointly and severably, and unlimitedly liable for debts of the joint venture.
Franchises are a very popular way of retailing products in the United States. Franchises are able to use trademarks of the parent company in return for agreeing to operate the business within the guidelines of the franchise agreement.