Hi everyone. Remember that when setting up your company, you face a number of crucial decisions. In this article we’ll address how to choose the various forms of business organization (also known as company structures) and help you determine which one is right for you. We’ll also look at how to create and implement a stock option program. Bear in mind that the majority of these issues will be handled by your attorney and controller, which are two functions you will outsource. You must, however, choose the structure best for you and your company, at least initially. As your business evolves, so will your company’s needs. Your goal in the beginning is to create a basic understanding of the structures available to you.
As I outline the proprietorship, partnership, and corporate forms of business, and describe the benefits, risks, & basic tax aspects of various organizational forms, please keep in mind that you will need to discuss this information with your attorney and accountant. I don’t profess to be an expert in knowing the exact structure that will be best for you. You’ll want legal and accounting advice based on your financial and tax profile to make this decision. Having said that, these are the basics to keep in mind as you go forward. There are many ways to organize your business. You can use Proprietorships, Partnerships-both General and Limited, Corporations-both C corporations and S (or Subchapter S) corporations, and Limited Liability Companies (or LLCs) or “Hybrids” of these company types. Let’s look at the definition as well as pros and cons of each.
Proprietorships. A Proprietorship is a business venture owned by an individual who is personally liable for the venture’s liabilities. Many entrepreneurs start out as sole proprietorships. I don’t like this company structure because as I stated moments ago, you will be personally liable for your company’s liabilities. You’ll have unlimited liability, meaning your personal obligation to pay the venture’s liabilities are not covered by the venture’s assets. Yuck and ouch. First, your company must be a separate entity. It needs to start developing its own credit (do this by getting a VISA or Amex small business credit card and/or credit line at your local bank) plus it needs to take care of its own liabilities. You can’t grow a business with this structure-it is too risky.
Partnerships. A Partnership is a business venture owned by two or more individuals who are jointly and personally liable for the venture’s liabilities. With Joint Liability legal action treats all partners equally as a group. Joint and Several Liability allows subsets of partners to be the object of legal action related to the partnership. This is an okay structure for certain types of ventures, but I still prefer having your company be less tied to yourself as an individual.
Limited Partnership. A Limited Partnership allocates liabilities in a partnership to the amount of each partner’s equity capital contribution to the partnership. This means that if you own 50% of the company, you have the burden of 50% of the liabilities, and the remainder are allocated to your partners pro rata based on their ownership percentage. Better, but still too personal for my taste!
Corporations. Ahhh… my favorite category of company structure. Here’s why.
- Corporation: a legal entity that separates personal assets of the owners (shareholders) from the firm’s assets. Nice and tidy.
- Limited Liability (aka LLC): creditors can seize the corporation’s assets but have no recourse against the shareholders’ personal assets. Good. An LLC is a business organization owned by “members” (shareholders) with limited liability. The major Incentive for organizing as an LLC is that earnings can be taxed at the personal income tax rates of the members.
- S Corporation: provides limited liability for shareholders plus corporate income is taxed like personal income to the shareholders. Good.
Tomorrow we’ll go over some of the criteria for choosing which type of set up is best for your company.